Another interest rate hike? Don't bet on it just yet

Another interest rate hike? Don't bet on it just yet Policymakers are hawkish on inflation, but RBI is more likely to raise them further

House owners who have opted for floating rate loans to fund their dream homes are having sleepless nights. Thanks to the Reserve Bank of Indias steep hike in policy rates and the resultant increase in home loan interest rates by housing finance companies and banks, many of them have seen their equated monthly instalments (EMIs) balloon considerably. With the fuel price hikes — petrol prices were hiked by Rs 5 a litre last week and diesel and cooking gas prices are expected to be hiked soon — expectations are that inflation will trend higher in the months to come. The Reserve Bank of India (RBI) and the government have sounded their worries on inflation and that is taking up expectations of more monetary policy tightening down the line. However, the fact that policy makers are hawkish on inflation may not necessarily translate into policy measures, especially on the monetary front. The RBI is more likely to hold on to its high policy rates than raise them further. Most are also anxious about the future course of interest rates, as most bankers aver that the banking regulator hasnt finished with monetary tightening yet they believe the central bank may hike policy rates further by another 50-75 basis points (100 basis points = 1%) during the financial year. It is true that home loan EMIs have gone up considerably.Those who have opted for 8% teaser loans are potentially paying 12%. In 2009, leading lenders such asthe State Bank of India (SBI ), ICICI Bank and HDFC, among others, had introduced the so-called teaser home loans, where the interest rates were kept artificially lower-mostly 8.0-8.5% than the market rate in the first three years. The interest rates prevailing in the marketcurrently at around 12% would apply to these loans from the fourth year onwards. According to experts, home loan interest rates have gone up by 3-5%,with existing customers paying anywhere between 12-15%. What makes matters worse is that these home loan customers dont have many options to wriggle out of the situation. Unlikein the past, one cant advise them to shift to a lower interest rate with another bank because that option doesn't exist anymore. It is not worth the effort to shift to another bank which will offer you loans at half a percent or one percent lower rate.Unless you are getting the loan at 2% lower rate,you wont save much. Also, the difference in the rates between the new bank and the old bank is unlikely to remain the same forever. Sooner or later the gap may narrow. A customer has two options before him if the EMI has gone up considerably and finds it difficult to service it. One, approach the bank and extend the term of the loan so that the EMI remains with manageable limit. Two, liquidate investments in fixed deposit or mutual funds and prepay a part of the loan so that the EMI comes back to reasonable level. The RBI has also been supported by tight liquidity conditions seen over most of the 2010-11 fiscal. The banking system was continuously accessing funds from the central bank since June 2010. Tight liquidity conditions have forced banks to hike lending rates, which has resulted in credit growth slowing down from levels of 24% to levels of 21% over the last one year. Loan growth will slow down further as the latest round of rate hike, of 50 bps, filters down into higher lending rates. The government, too, has reversed its borrow-and-spend policy. Fiscal deficit is projected at 4.6% of the gross domestic product (GDP) for 2011-12 against a high of 6.8% of GDP seen in 2009-10. Fiscal deficit came off to 5.1% of GDP for the year 2010-11. The government is still subsidising fuel, but with the latest round of fuel price hikes, the fuel subsidy bill is likely to reduce from high projections of Rs 200,000 crore for this fiscal. The consumer will now have to pay more for fuel as well as incurring higher borrowing costs and this will lead to a fall in aggregate demand. The external factor of high commodity prices including oil will always be a threat to inflation. However, with central banks across the world from Europe to China tightening policy, demand may come off, leading to commodity prices stabilising, albeit at higher levels. Given that primary inflation drivers as mentioned above are showing signs of cooling off, the RBI will hold policy rates status quo though policy will remain tight till inflation expectations turn around completely.