Are we heading towards high interest rate regime?

The decision of India’s largest public sector bank, State Bank of India (SBI), to hike the interest rate on retail deposits, followed by an increase in MCLR (marginal cost of funds-based lending rate) by up to 20 basis points may be a precursor to the upward movement of interest rates going forward. So are we heading towards a higher interest rate regime six months down the line, or is it just a one-off rate hike that one can ignore?

According to money market experts, the liquidity in the money market has declined towards the end of FY2017-18, which has prompted banks such as SBI to go for a rate hike to attract deposits from the public. The banks were flush with excess liquidity for a while after the demonetisation drive, but more than a year down the line after demonetisation, all the excess liquidity appears to have been drained out of the system. Now, the banks appear to be keen to raise money and rate hike by SBI may be viewed as a step in that direction. Other private and public sector banks are expected to follow suit sooner rather than later.

The hike in interest rates is good news for depositors who would welcome this and any subsequent rate hikes by the banks. Some of the banks had hiked their MCLRs and subsequently the bulk deposit rates over the last couple of months, but now the banks are hiking rates on retail fixed deposits.

However, it would be premature to assume that the hike in interest rates signals a high interest rate regime going forward. The rate hikes would be in response to rising bond yields, rising inflation and declining liquidity. Hence, the hikes are expected to be gradual, punctuated by quarterly and half-yearly time lags.

While depositors will rejoice at every rate hike, the borrowers will sulk as they would have to shell out more for every rupee borrowed. Interest rates on home loans, personal loans, consumer loans and various other loans are expected to see upward movement with every rate hike by the commercial banks.