As inflation in India continues to rise and stays beyond the RBI’s comfort zone of 6 per cent for 10 straight months, the central bank has been raising repo rates since May to curb liquidity in the system.
The Reserve Bank of India (RBI) has raised repo rates four times since May and it is expected to hike the key lending rates again on December 7.
Though high interest rates help in curbing liquidity to check inflation, it does not necessarily leave a good taste in the mouth for bourses. Higher interest rates translate into a decline in stock market’s value.
This is because when interest rates rise, companies tend to borrow less. As a result, their earnings suffer from slow growth, thus hurting the investors, say market watchers.
This in turn leads to a kind of a ripple effect on the stock market, as the stocks in which investors put in money, expecting decent annual growth, don’t give the desired returns. This is because the company’s growth (whose shares the investor has purchased) has been hampered due to the high interest rate regime.
N.R. Bhanumurthy, Vice Chancellor of Dr B.R. Ambedkar School of Economics University, Bengaluru, offers a slightly different but interesting insight into the whole high interest rate versus the stock market scenario.
“With regard to raising interest rates, one has to keep in mind that although interest rates are moving upwards, it does not show much impact on the real interest rates, which is the variable that investors look at,” he says.
“Its impact on the stock markets appear, however, to be mixed, especially when we look at the recent trends in the Indian stock market, which has been bullish despite interest rates being hiked. It has also been the experience of advanced economies.”
This bullish tendency, he says, is mainly due to positive sentiments on the Indian economy, which continues to be one of the world’s fast-growing large economies.
On the RBI’s role going forward, Bhanumurthy says: “RBI has been managing the inflation as well as inflation expectations pretty well. However, it is also important to understand that the recent domestic interest rate hikes are more due to open-economy macro issues and less due to domestic inflationary pressures.
“The hikes are largely to address the capital outflow issue and also to address exchange rate volatility.”
Now that US Fed has already suggested benign interest rate hikes, this could also influence RBI in moderating interest rate hikes in the near future, he notes.
“We might see one more round of hike and with that interest rates expected to peak,” he predicts.