Mumbai: The Indian central bank sprang a surprise by increasing two key policy rates almost exactly a month ahead of schedule, a sign that it is now less focused on supporting the economic recovery and more concerned about resurgent inflation.
The Reserve Bank of India (RBI) said in a statement on Friday that it was raising the repo and reverse repo rates by 25 basis points each with immediate effect, to 5% and 3.5%, respectively. These are the rates at which the central bank lends and borrows overnight money from banks. Most economists and bond traders were expecting such an announcement only when RBI was to unveil its new monetary policy review due on 20 April.
This is the first interest rate increase since July 2008. RBI had cut interest rates between October 2008 and April 2009 to combat economic weakness.
The Friday statement mentioned that inflation was spreading from food to other goods and that the recovery in private demand would further add to inflationary pressures. The wholesale price inflation rate for February came in at 9.9%, above the baseline projection of 8.5% made by RBI in January for the end of the current fiscal. “The Reserve Bank will continue to monitor macroeconomic conditions, particularly the price situation, and take further action as warranted,” the statement said, sending out a signal that further rate hikes are likely in the months ahead.
Economists expect these to happen soon. “The current level of inflation is socially unacceptable and there was a general perception that RBI is behind the curve. We expect RBI to hike both repo and reverse repo rates by another 25 basis points each in the upcoming policy review on 20 April,” said Rupa Rege Nitsure, chief economist of Bank of Baroda.
Graphic: Ahmed Raza Khan / Mint
Added A. Prasanna, economist at ICICI Securities Ltd: “I would not call it a desperate measure. The inflation is above RBI estimates and we expect another round of policy rate hike by 25 basis points in the April review.”
The increase in the two short-term rates will likely push up the borrowing costs of companies and consumers. But bankers are expected to wait for the next rate hike as well as the move to a new method of calculating lending rates in July before they follow the central bank’s cues.
“Banks are expected to wait for the April policy review before they decide on a possible rate action. With the new base rate regime also kicking in on 1 July, banks will wait for some time before they take any decision on a rate hike,” said Prasanna. “The 25-basis point hike will have very minimal impact on banks’ lending rates,” said Rana Kapoor, managing director and chief executive of private sector lender Yes Bank Ltd.
Chanda Kochhar, managing director and chief executive of ICICI Bank Ltd, said: “RBI’s move reflects the growing confidence in the recovery of growth in the Indian economy and is in line with RBI’s stated objective of anchoring inflation expectations. We need to wait and see the credit offtake and systemic liquidity to assess the medium-term impact on lending and borrowing rates.”
The strong recovery in the current fiscal has emboldened policymakers to start withdrawing the stimulus measures introduced to protect it from the savage global downturn that began in the last quarter of 2008.
The government had said on 26 February that it would begin a process of cutting its fiscal deficit—the broadest measure of budget imbalances—and now the central bank has decided to reverse the direction of interest rates.
The RBI action came after the equity and bond markets had closed for trading.
The yield on the 10-year benchmark government bond ended at 7.83%, after matching Thursday’s three-week low of 7.81%. It had ended at 7.9% on Thursday.
The key Sensex index of the Bombay Stock Exchange recorded its sixth straight weekly gain. Coupled with positive global markets, the rally was led by Reliance Industries Ltd and Bharti Airtel Ltd.
Sentiment was buoyed after rating agency Standard and Poor’s upgraded its outlook on India to stable on Thursday, citing an improving fiscal position and on the back of strong economic growth.