Quick Notes: Rate Hike Implication on India’s Economy June 8, 2018
We look to furnish investors with our view on RBI's recent surprise rate hike.
Author : Tan Wei Yine

Quick Notes: Rate Hike Implication on India’s Economy

The Reserve Bank of India (RBI) increased the policy repo rate under the liquidity adjustment facility by 25 basis points two days ago, the previous hike was done a little more than four years ago. This falls out of our expectations for a hold, as we have previously opined that RBI’s neutral stance could stimulate borrowing appetite in helping to sustain the revival in industrial and private sector’s capex recovery.

What drove the rate hike move?

All members of India’s Monetary Policy Committee (MPC) have voted unanimously for a rate hike in the recent meeting. Our interpretation from the press release document is that RBI is in view that India’s economy is currently experiencing a broad-based recovery in growth, and leading indicators are building a stronger footing for the economy in months ahead.

More importantly, the rising of commodity prices along with robust aggregate demand have started to buoy input costs. As a result, core inflation figures are creeping to levels above RBI’s target of 4% in recent months. Eventually, the aforementioned factors gave sufficient reasons for the members to hike interest rates.

Our view

While inflation figures may be ticking higher, we still think that reform pains are still far from over. Our take is that the central bank has taken the initiative to contain inflation but is keeping a neutral stance, portraying its vigilance to prevent choking off the current recovery momentum on the macroeconomic front.

Although the rate hike was done on the baseline to contain inflation, which could be a plus for consumers who are still acclimatizing with the GST introduced last year, we think the move may very well reduce borrowing appetite within the private sector. However, the on-going recovery in other segments of the economy could help offset a slower investment growth.

Looking towards equities, primary beneficiary from the rate hike move would be the banking sector, where higher interest rates generally translate to higher net interest margin. Our main concern now is whether private companies would face difficulties in servicing debts with higher interest rates now. We are keeping a close watch in this area closely.

Given that India’s economy is still trekking the path of recovery and reform pains are just starting to show signs of easing, our base case is that there will not be another rate hike for the rest of 2018. While there is possibility of another rate hike due to the persistence in crude oil and commodity prices, we think that the occurrence of a series of rate hikes is very unlikely.

All in all, we are maintaining our stance towards Indian equities. At this juncture, we do not think India is a strong buy, simply because valuation remains fairly expensive from a short-term perspective. For investors who are looking at a longer investment horizon (>3 years), however, we think now could be a better opportunity to gain exposure to Indian equities, given that future valuations are looking attractive. Investors could tap into the investment opportunities in India via Manulife India Equity Fund.

See also: India: Don’t chase for short-term gains

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