RBI comes with a decision to increase the lending rate on funds to banks by half a percentage point to fight inflation. This step taken by RBI will lead to a minimum increase of 50 basis points in interest rate. Some banks are likely to increase the rate even to 75 basis points. Private sector banks might increase their lending rate to one percentage point (100 basis points). There is a possibility for many, to increase the rates by one percentage point from July1, 2008. This happened because of the inflationary pressure which has led to an increase of interest rates.
Presently, RBI has adapted the present tight money policy to contain inflation. However, this step will affect more of those banks which normally borrow in the overnight money market to meet their lending requirements. Many banks had not increased their lending rates during the time when RBI had increased its rep rate any cash reserve ratio in April. Actually, Banks had absorbed the interest rates come down. However, inflationary pressure got aggravated and RBI had to tighten the money supply. Hence, banks have no choice but to increase the rates. It is understood that the cash reserve ratio has been increased by 1.25 percentage point in the last three months to 8.75%. The interest rates are all set to go up even further. This will make the people to act in a more cautious way. There will be a tendency for people to postpone purchases for some time. However, I hope to see things to stabilize when inflation is controlled.
With regard to inflation, RBI has decided to raise the lending rate on funds to banks. There is already an increase with cost of funds by 45 basis points. Also, since there is a hike in the repo rate, banks will be forced to hike the rate by 50 to 100 basis points. It is the home loan borrowers who are badly hit by this issue.
As the rates are increasing, the default rates will also go up. The cost of funds will increase. This situation will force the banks to further hike the rate. Now, as the interest rates goes up, the value of the government securities will fall. Banks will then be left with no choice but to lend at much higher than the prime lending rates, which may increase by only 50 basis points. Hence, the difference between real rates, that a customer will have to pay the bank, will be higher than the rate that the bank will fix for its best of the customers.
It is important to know that an increase in the interest rate by 100 basis points on a 20 year loan, leads to increase in EMI by almost 7%. Also, in the case of other consumer loan, the increase in the rate will be higher than one percentage points. The RBI is likely to sell dollar to contain the depreciation of rupee. Due to the rupee’s depreciation, there is an increase in the import cost. This has further contributed in the rise in the domestic prices. The liquidity will be further tightened. All this will only lead to a worse condition for borrowers.