1% rate hike may up housing EMI by 7%

Interest rates are all set to go up by 50-100 basis points, following the RBI's decision to increase the lending rate on funds to banks by half a percentage point. Punjab National Bank (PNB) CMD K C Chakrabarty said the step taken by RBI will lead to a minimum increase of 50 basis points in interest rate. Some banks might increase the rate even to 75 basis points, he added.

However, a senior official of a private sector bank said increase in the lending rate might go up to one percentage point (100 basis points). As the interest rates are going upward for last quite some time and not likely to come down in the near future due to inflationary pressure , many banks will increase the rates by one percentage point from July 1, 2008.

CMD of Union Bank MV Nair said the present round of increase in the policy rates will force them to raise their prime lending rates by 50 basis points to 13.25% from the present 12.75%.

He said the present tight money policy pursued by RBI to contain inflation will affect more those banks which normally borrow in the overnight money market to meet their lending requirements. Because of rise in the repo rate by 50 basis points to 8.50%, the interest rates on short term funds has gone up immediately.

In fact, many banks had not increased their lending rates, when RBI had increased its repo rate any cash reserve ratio in April.

A senior banker said that banks had absorbed them thinking that interest rate will come down. But as inflationary pressure aggravated, and RBI tighten the money supply further, he said, banks have no choice but to increase the rates.

According to a senior banker, the cash reserve ratio has been increased by 1.25 percentage point in the last three months to 8.75%. This alone has increased the cost on funds by 45 basis points. Besides this, because of repo rate hike, banks will be forced to hike the rate by 50 to 100 basis points.

The worst hit by this would be the home loan borrowers. A senior bank official said that as the rates are increasing, default rates would also go up.

This will increase the cost of funds, forcing banks to further hike the rate. At the same time, as interest rates are going up, the value of the government securities will also fall. To minimize these effects, CMD of a bank, who does not want to be quoted, said that banks will have no choice to lend at much higher than the prime lending rates, which might be increased by only 50 basis points.
That means, the difference between real rates that a customer will have to pay will be higher than the rate that the bank will fix for its best of the customers.

As shown in the chart, increase in the interest rate by 100 basis points on a 20-year loan leads to increase in EMI by almost 7%. On the other consumer loan also, the increase in the rate will be higher than one percentage points.

At the same time, RBI is likely to sell dollar to contain the depreciation of rupee. The rupee's depreciation has led to increase in the import cost, which has also contributed in the rise in the domestic prices. But, this will further tighten the liquidity. A senior banker said that such majors will only worsen the condition for borrowers.