The Reserve Bank of India’s decision to hike the repo rate by 25 bps has direct consequences on various sectors of our economy. While the most observable impact can be felt in sectors such as housing, whose growth is dependent on the availability of loans in the market and the interest rates, there are other consequences too.
The first hike in almost four-and-a-half years, it is likely to be seen as a reversal in the interest rate cycle. The bond market, which expected a 50 bps rate hike, didn’t have much to celebrate because of this move. The 10-year bond yield has gone up 6 bps but that can be attributed to the lack of clarity on open market operations and changes in liquidity coverage ratios, which are likely to impact the demand for long-term government bonds.
The government bond yields, at 8 per cent, and PSU triple-rated bond yields, at 8.5 per cent, are priced at a significant risk premium. There are inherent issues such as oil prices, behaviour of foreign investors closer to the election year, volatility in rupee movement and consequent liquidity actions, all of which impact the bond yield, leading to bond spreads remaining high. As is clear from the central bank bulletin, this hike is not an indicator of a long-term hiking cycle, but more to pre-empt emerging inflation risks.
Housing and auto sector
The impact of an increased repo rate is observable on other sectors too. For example, while it will not have much short-term impact on housing sales as the housing market is already sluggish, it could delay the revival of the sector. The RBI’s decision may lead to a subdued growth in the real estate sector as it requires lower rates if it wants to house everyone by 2022. The increased interest rate will impact allied sectors, such as steel, iron and cement.
The repo rate hike will have a direct bearing on auto loans as well. However, we need to look at the monsoon and measure its impact on demand for fast moving consumer goods and automobiles. With this year’s monsoon expected to be near normal, the demand for FMCG and automobiles is likely to be high.
The monetary policy notes also suggest that domestic economic activity has exhibited sustained revival in last few quarters and the output gap has almost closed. Investment activity is recovering well and, once the distressed sector issues are taken care of under the Insolvency and Bankruptcy Code, the investment scenario will improve. At least that’s what is expected for the upcoming election year. .
The central bank has retained the GDP growth rate at 7.4 per cent as in its April policy. Domestic growth is likely to be impacted by increased geo-political risk, financial market volatility and trade protectionism. However, the RBI estimates both rural and urban consumption will remain healthy in the near future.
Education loans
However, the most likely and negative impact of such a rate hike will be on demand for educational loans. Public sector banks, including State Bank of India, offer loans to students for higher education to the tune of ₹10 lakh for studies in India and up to ₹20 lakh for studying abroad. The repo rate hike is likely to increase the interest rates on student loans.
This rate hike could not have come at a worse time as this is admission season, when there is an increased demand for education loans. Public sector banks evaluate and disburse student loans with greater willingness than private sector banks. Unfortunately, some of the PSBs are on the regulator’s radar due to increased gross non-performing assets and bad loans.
The central bank has told a few banks to cap the level of loans they can issue; this will also affect students looking to study further. While the higher interest rates may extend the pay-back periods for future student loans, small-town money-lenders will, no doubt, benefit from such a stressful situation.
Non-banking finance companies and private sector banks should come forward to offer education loans to students to bridge the shortfall in availability of education loans. Large public sector lenders can tweak personal loan rates and reduce the impact of the repo rate hike on education loans.
There needs to be an ideological change, so that education loans are offered at a lower interest rate than personal and commercial loans. This cross-subsidisation of interest rates will help students at large and won’t significantly impact the loan portfolio of banks.
If we don’t look at options of cross-subsidising student loans at the cost of personal and other consumption-related loans, it will be like leaving a baby at Jurassic Park — where loan predators will eat up the talent and opportunities of the next generation and kill the intellectual upsurge that India has been experiencing in last few decades.
(The author is Professor and Dean, Jindal Global Business School, OP Jindal Global University and the views are personal.)