What’s Happening?
The Reserve Bank of India has only recently hiked the repo rate from 4% to 4.40%, but the US Federal Reserve started doing so as early as March 2022. Since then, the US Central banks have raised the short-term interest rate twice, by 25 bps and 50 bps in March and May 2022, respectively.
Also, the Bank of England raised the country’s short-term rates to their highest levels since 2009 and has also warned of a looming recession!
Why This Move?
Central Banks worldwide resort to this move when controlling inflation becomes a priority over achieving growth. Lately, inflation rates have been outside the RBI’s target range of 2-6% for more than a couple of months.
A repo rate hike will make it costlier for Indian banks to borrow from the RBI. Banks will, in turn, pass on this increased cost to borrowers by increasing their lending rates. This will mean a costlier borrowing than before, which will lead to a decrease in credit demand, and a decrease in the money floating in the economy. In a way, this will suck out excess liquidity from the economy, which will bring down inflation levels.
Also, higher borrowing costs mean increased financing costs for companies having debt on their balance sheets. Higher financing costs lead to decreased net profits, which is negative for companies. This will eventually get reflected in their stock prices.
What Should Investors Make Of It?
Although rate hikes are negative for stocks, one asset class that performs well during periods like these is short-term bonds, providing increased returns.
Also, within stocks, investors can start hunting for quality companies with consistent cashflows and a credible moat and sound management if they are available at depressed prices.
