Both retail and corporate borrowers will have to brace for a prolonged period of high interest rates as the Reserve Bank of India will continue to fight inflation to protect the long-term growth story. The central bank surprised markets on Tuesday with a hefty 50 basis points increase in key short-term interest rates.

Private and public sector banks said they would have to raise interest rates further to protect net interest margins (NIMs). Companies said interest costs were pinching and they would look at external sources to raise funds. Banks will also raise deposit rates so that they can garner enough resources at competitive rates.

Credit growth is expected to slow down and already the pace has decelerated with growth in home and auto loans slowing.

The RBI expects inflation to stay elevated in the near term and may continue to raise rates until inflation is firmly under control.

“As long as inflation persists, there will be no significant change in our policy stance,” D Subbarao, RBI governor, told reporters at a press conference.

Pratip Chaudhuri, chairman & managing director of State Bank of India, told reporters at a press conference that the bank would have to raise both lending and deposit rates, adding that the quantum, however, cannot be specified now. “If we do not raise rates, our NIMs will be impacted,” he said.

“We will have to scale down growth to stay profitable and focus on treasury operations and increase investments in government securities,” said Chaudhuri.

Companies said they expected interest rates to rise on domestic loans and they would be forced to go abroad for funds.

Larsen & Tourbo’s chief financial officer and board member YM Deosthalee said when domestic credit was more expensive companies would look at overseas borrowing to raise funds so that overall costs were under control.

“Our infrastructure special purpose vehicles (SPVs) have bank borrowing where the interest cost is expected to rise at specific intervals. But the impact would be more on interest-sensitive sectors such as housing and FMCG, among others,” he said.

Soon after the RBI announcement, private lender Yes Bank raised its base rate and prime lending rate by 50 basis points to 10.25 per cent and 19.5 per cent respectively.

DD Rathi, group executive president, Aditya Birla Management Corporation, said, “High interest rates have begun to pinch companies. Sharp increase in interest rates will force Indian companies to defer expansion plans, which, in turn, will impact growth. While part-funding can be made through overseas borrowing, remaining funding will have to be from domestic sources at high interest rates, impacting profitability,” he said.

However, credit growth of banks would be impeded as companies would look at alternative sources of funds. Already SBI, the largest bank, which controls about 15 per cent of bank advances said it would have to prune credit and deposit growth as demand for loans would be muted.

MD Mallya, chief of Indian Banks’ Association, said interest rates were headed upwards and would continue for a while. “Banks will have to assess their funding cost and arrive at the percentage hike they will pass on to borrowers.”

The big worry for banks is the formation of bad loans that will increase provisioning, which will hit profits. Most public sector banks have reported a drop in profit margins due to higher provisioning.

Chanda Kochhar, CEO & MD of ICICI Bank, said policy actions since last year and the systemic liquidity conditions had led to an increase in deposit and lending rates. “In the first quarter, there have been some signs of moderation in credit growth. Banks would review the movement in funding costs and effect further increases in lending rates based on the same,” she said.

However, the RBI is of the view that though growth is beginning to slow down it is restricted to interest rate sensitive sectors only. Several indicators like exports, imports, indirect tax collections, corporate sales and earnings and demand for bank credit suggest that demand is moderating only gradually.

Aditya Puri, managing director of HDFC Bank, said, “The hike in rates will have to be passed on and it will have a marginal impact on GDP growth.”

The move on Tuesday was the most aggressive stance taken by the RBI since it started tightening rates in March 2010. In the first quarter it had raised rates by 75 basis points.

Anil Kothuri, executive vice-president of Edelweiss Housing Finance, said home loan rates would rise again. “The cumulative increase over the past year will test the budgets of those repaying loans. It will also reduce the eligible loan amount for new home loan applicants.”