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RBI raises key policy rates to tame inflation

RBI raises key policy rates to tame inflation
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First Published: Sat, Jul 03 2010. 12 40 AM IST

Yogesh Kumar / Mint
Yogesh Kumar / Mint
Updated: Sat, Jul 03 2010. 12 40 AM IST
Mumbai: The Reserve Bank of India (RBI) on Friday raised its key policy rates, for the third time this year, by a quarter of a percentage point each, three weeks ahead of its quarterly policy review, to fight rising inflation in the world’s second fastest growing major economy.
It also said it will revise its growth projections for the economy from its “8% with an upside bias” as “recent data suggest that the upside bias has largely materialized”.
Yogesh Kumar / Mint
The Indian central bank raised its repo and reverse repo rates to 5.5% and 4%, respectively.
Repo is the rate at which RBI lends money to commercial banks and at the reverse repo rate it drains out surplus liquidity from the banking system.
Economists expect another round of a quarter percentage point rate hike on 27 July when the central bank reviews its monetary policy.
A hike in policy rate will make money costlier for corporations and retail borrowers even though banks do not seem to be in a hurry to raise their base rate as yet. The base rate is the rate below which banks cannot price any loan.
However, the impact of the policy rate hike will be seen in the bond market on Monday and the bond dealers expect the yield on the benchmark 10-year paper to go up by around 10 basis points.
One basis point is one-hundredth of a percentage point. Bond prices and yields move in opposite directions.
On Friday, the yield on the 10-year paper closed at 7.58%.
RBI announced the rate hike after the market hours and auctions of three government bonds, raising Rs10,000 crore.
Finance minister Pranab Mukherjee said the RBI measures “are desirable given that core inflation has risen and credit situation is tight”. It is “good that RBI has not raised cash reserve ratio (CRR)” of banks.
RBI had earlier raised banks’ CRR, or the portion of deposits that banks need to keep with it, by one percentage point in two stages, but has refrained from raising it further this time as there is not enough money in the system.
In fact, RBI has taken quite a few measures to infuse liquidity in the system in the past one month.
The market was expecting a hike in policy rate as wholesale price inflation jumped to 10.2% in May and is expected to rise even further following the government decision to deregulate petrol prices and raise diesel, kerosene and cooking gas prices. The growth in industrial production has also been very high, signalling the robustness of economic recovery.
“Although entirely justified in terms of long-term fiscal and energy conservation objectives, the recent increase in fuel prices will have an immediate impact of around one percentage point on WPI (Wholesale Price Index) inflation, with second-round effects being felt in the months ahead,” RBI said in its release.
RBI noted that two-thirds of the wholesale inflation in May was contributed by non-food items, “suggesting that inflation is now very much generalized and that demand-side pressures are evident”.
It also said economic “recovery is consolidating” and “the strong underlying growth momentum” is evident from the sharp upturn in the capital goods sector, acceleration in credit growth and the widening current account deficit.
Yet another positive factor is the relatively smooth progress of the monsoon, which so far has been “decidedly better than during last year”.
“The liquidity will be improving faster than what many of us expect,” said Indranil Pan, chief economist at Kotak Mahindra Bank Ltd.
Saugata Bhattacharya, chief economist of Axis Bank Ltd, is surprised by the “timing of the hike”. According to him, the liquidity in the system is expected to remain tight until mid-July.
“Repo, reverse repo rates have no direct impact on the base rate,” said K.R. Kamath, chairman and managing director of Punjab National Bank, indicating no change in loan rates.
Bank of Baroda chairman M.D. Mallya said there may not be that much of pressure on the deposit rates that could force his bank to alter the lending rates.
Union Bank of India chief M.V. Nair also ruled out altering his bank’s base rate till the “the next quarter”, even if RBI goes ahead with another 0.25% tightening in its July policy.
Anita Bhoir contributed to this story.
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First Published: Sat, Jul 03 2010. 12 40 AM IST