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Fitch Ratings on Tuesday said the Reserve Bank is likely to raise interest rates further to 5.9 per cent by December 2022, on deteriorating inflation outlook.

In its update to Global Economic Outlook, Fitch said India's economy faces a worsening external environment, elevated commodity prices, and tighter global monetary policy.

"Given the deteriorating outlook for inflation, we now expect the RBI to lift rates further to 5.9 per cent by December 2022 and to 6.15 per cent by the end of 2023 (vs. previous forecast of 5 per cent) and to be unchanged in 2024," Fitch said.

Last month in an unscheduled policy announcement, the Reserve Bank of India (RBI) raised rates by 40 basis points to 4.4 per cent, and subsequently to 4.9 per cent last week.

The RBI has forecast inflation to be 6.7 per cent by the end of current fiscal. The retail inflation for May came in at 7.04 per cent.

"Inflation has risen to an eight-year high and broadens across more CPI categories, posing a severe challenge to consumers. In the past three months, food inflation has increased by an average of 7.3 per cent year-on-year, while healthcare bills are rising at a similar pace," Fitch said.

According to Fitch, the April-June quarter growth is likely to improve on a rebound in consumption as COVID-19 cases subsided towards end-March.

"GDP grew by 4.1 per cent year-on-year in 1Q22 (January-March) compared to our March forecast of 4.8 per cent. We now expect the economy to grow by 7.8 per cent this year (2022-2023), revised down from our previous forecast of 8.5 per cent," Fitch said.

Fitch had last week upped outlook on India's sovereign rating to 'stable' from 'negative' after two years citing diminishing downside risks to medium-term growth on rapid economic recovery. The rating was kept unchanged at 'BBB-'.

The Outlook revision reflects our view that downside risks to medium-term growth have diminished due to India's rapid economic recovery and easing financial sector weaknesses, despite near-term headwinds from the global commodity price shock," it said.

The Indian economy grew 8.7 per cent in the last fiscal and RBI expects growth to be 7.2 per cent this fiscal.

Amid opposition from rich nations, India has called for inclusion of ‘therapeutics and diagnostics’ — testing and treatment of a disease — as part of the temporary patent waiver agreement that can pave the way for the future need to tackle any crisis.

Twenty months ago, India and South Africa had urged the World Trade Organisation (WTO) member nations to agree to temporarily waive some sections of Trade-Related Aspects of Intellectual Property Rights (TRIPS) to ramp up production of vaccines, therapeutics, and diagnostics to combat the Covid-19 pandemic. The draft agreement, however, falls short of the original proposal and includes only vaccines.

At the 12th ministerial conference at Geneva, Commerce and Industry Minister Piyush Goyal said there was a need to redouble efforts and commence negotiations on therapeutics and diagnostics, since the pandemic was far from over, particularly for the developing and least-developed countries. Besides, it is too late in the day if only vaccines are included as the pandemic has run its initial course, he said.

“While vaccines were for preventive need, we need to ramp up manufacture of therapeutics and diagnostics to achieve a comprehensive test and treat strategy or workable waiver or let’s say an enhanced, compulsory licensing, as we say, can deliver in some measure what it was set out to achieve. Vaccines are no longer in scarcity and affordable stocks available across the world,” Goyal said at the thematic session on ‘Response to Pandemic’.

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“In the course of my discussions, it has been indicated that many countries do not favour supporting what has been asked. Well, if it’s only vaccines that we are looking at providing, I think it's too late in the day for that,” the minister said, adding that it was unfortunate that the profits of the pharmaceutical behemoths prevail over global growth.

India and South Africa and 63 co-sponsors had initially made the TRIPS waiver proposal to help middle- and low-income nations get access to Covid-19 vaccines and drugs. However, the discussions reached a deadlock in the TRIPS Council — a body responsible for monitoring the operation of TRIPS agreement.

The minister said the draft text from these discussions did not reflect what India as a co-sponsor of the waiver proposal had envisaged. The commencement of text-based negotiations allowed the larger membership to engage in discussions on the texts. “I was really hopeful that the remaining concerns with this text would have been resolved and reconciled. For India, a consensus-based outcome is of paramount importance,” he said.

Goyal also said India had made several compromises to enable submission of a ‘clean’ document on the “Response to Pandemic” at the ministerial.

The compromises include the TRIPS automaticity clause, which was not accepted, extensive dilution of the language on intellectual property, and tech transfer, among others. “I hope that the flexibility that we have shown will pave the way for its acceptance and be replicated in other tracks for a successful MC-12,” he said.

Outcome on WTO’s response to the pandemic, which includes the TRIPS Waiver proposal, is one of the priority items for MC12.

Demonetisation in November 2016 was a challenge for many businesses, especially the small and medium enterprises (SMEs). It was, however, a boon for banks that saw a large growth in their deposits. Cash stashed away by households found its way into bank accounts. From 2015 onwards, industrial credit slowed down very sharply to hit a several decades low of around 5 percent in 2017, and after a blip up in 2018, continued slowing down.

This trend of deposit growth being higher than credit growth goes back to the financial year 2015. Deposits growth remained at double digit throughout this period. With deposit growth at double digit, and credit growth between 5 and 7 percent, banks were floating on easy liquidity.

As the COVID-19 pandemic hit in 2020, the Reserve Bank of India (RBI) unleashed additional liquidity and policy rate cuts that saw them hit all-time lows. For bank managers, the real challenge in the last five years was finding credit growth, and managing the impact of the pandemic on credit quality and on the organisation. For almost eight years, growing deposits was not a challenge.

This easy period of deposits for banks is coming to an end, and in the next couple of quarters we are likely to see the beginning of an intense competition for deposits. The RBI is on a clear and aggressive path of rate hikes and liquidity squeezing. The May and June policy rate hikes by the RBI’s MPC will be followed by similar hikes in August and September. Higher rates will ultimately be transmitted by banks on both sides of the balance sheet — in the pricing of loans, and deposits.

In the past, increasing policy rates were beneficial for banks as the transmission was asymmetric — quicker and larger for loans than that for deposits. In this cycle, it is likely to be different, and we may see sharper pricing up for deposits than loans. This relatively larger and quicker rate transmission on the deposit side will be driven by four factors.

First, credit growth will remain strong. While consumer credit will slow down due to higher interest rates, the demand for working capital from business will remain strong. Rising commodity prices are driving working capital demand as the cost of inventory has gone up. There are some early signs of capex revival which may further drive credit demand. After nearly five years, we are seeing credit growth in double digits. The policy of withdrawal of liquidity along with high credit growth will mean that the demand for deposits will increase.

Second, households are facing serious inflation that will dent savings. In addition to cost-of-living increases, households will see increase in the costs of borrowing. Over the last seven years as the industrial credit growth stagnated, banks and non-banking finance companies (NBFCs) have lent freely to households, and these consumer loans now form a larger share of the banks’ loan book than industrial credit. This expansion of consumer credit has been primarily in the top two income deciles of households which also are the biggest contributors to household savings.

From 2019, regulations have mandated the interest rate on all the consumer loans to be linked to external benchmark such as the repo rate or T-bill yields. These loans will, therefore, be priced sharply upwards. In case of longer maturity loans such as home loans, lenders will try to keep the monthly payments constant by extending the maturity of the loans. However other loans that constitute nearly 50 percent of consumer borrowing, such as personal (unsecured loans), vehicle loans, etc. will all see increase monthly repayments. The net effect of these rate hikes will be that households that contribute most to the banking deposit base will see their net savings (savings after loan repayments) shrink significantly.

Third, as the rate cycle peaks around October/November, debt mutual funds will become a very attractive alternative to investors. The yields on five-year AA corporate bonds have already started inching closer to 10 percent, and with the forthcoming policy rate hikes these yields will further go up. High-quality corporate bonds funds comprising AAA and AA rated papers, could start delivering double-digit yields as the rate cycle peaks. This would entice high network individuals (HNIs) and institutional depositors to move their money from deposits to these funds. Bear in mind that funds, held over three years, provide a sizeable tax advantage over deposits.

Finally, the COVID-19 pandemic has seen a very rapid increase in the adaption of digital tools — mobile apps especially – to conduct banking transactions. Thanks to these tools, opening new accounts and moving money between them is way easier now than was the case even three years ago. These tools, thus, make deposits much more fungible than before. It is much easier to woe a depositor by offering a higher rate than was the case just a few years ago. Digital technologies have also made it much easier now to move money from deposits to mutual funds.

The net effect of these factors is that the deposit market is now much more contestable. It is also important to note that over the last five years, several new players – the small finance banks and payment banks – have entered as competitors for deposits. Even the handful of deposit-taking NBFCs that have not focused much on raising retail deposits in an era where wholesale funding from banks and bond markets was very aplenty and cheap, would become active and aggressive in raising deposits.

Intensifying competition for deposits will mean that the cost of deposits will go up, and it will dent margins, unless the cost hike is passed on to the borrowers. Given the nascence of credit growth, it seems unlikely that there will be full pass through of deposit rate increases to loans. Bank margins will come down.

After a long time, bankers will realise that theirs in a unique business that must compete on both sides of the balance sheet. They will have to get ready to face something they haven’t for a very long time: intense competition for deposits.