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Loans to get costlier as RBI hikes MSF to prevent rupee fall

Loans to get costlier as RBI hikes MSF to prevent rupee fall
While economists and analysts were focusing on what the RBI would do in its forthcoming Monetary Policy on July 30, the Indian central bank stunned markets by hiking the marginal standing facility for banks (MSF) to 10.25%, indirectly pushing interest rates higher.

Under the MSF banks were borrowing from the RBI at repo rate, plus 1 per cent, which effectively meant 8.25 per cent. But, with effect from July 17, banks would now have to borrow at 10.25 per cent, which is a good 2 per cent over and above the existing rates.

This along with the proposed open market sales of government securities is expected to drain liquidity and push interest rates in the system higher.

Bankers say that this is an indirect measure to hike rates, without actually tweaking the repo rates. However, the move is aimed at increasing the carry over dollar costs, so as to ensure that speculators do not short the Indian currency, which would then give a big boost to the rupee.

The rupee is now expected to open higher in trade today.

In other significant move the RBI also fixed the limit for borrowing at 1% of the of the Net Demand and Time Liabilities (NDTL) of the banking system, reckoned as Rs.75,000 crore for this purpose. The allocation to individual banks will be made in proportion to their bids, subject to the overall ceiling. This change in LAF will come into effect from July 17, 2013.

To further drain liquidity from the system the Reserve Bank will conduct Open Market Sales of Government of India Securities of Rs.12,000 crore on July 18, 2013.

Clearly, as banks have to borrow at higher rates from the central bank the interest rates seem headed higher, as cost of funds for banks increase. It's possible that we might see banks hiking their deposit rates and lending rates in the next few weeks.

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