Mumbai: India’s central bank, Reserve Bank of India (RBI), intensified its fight against inflation by increasing its policy rate, which will likely have a bearing on the rate at which banks lend to firms as well as individuals, by one quarter of a percentage point to 8%.
It will also result in an increase in the interest rate on bank deposits.
The RBI’s out-of-turn move comes after the bank tried to contain inflation, now at a four-year high of 8.24%, by raising the balance banks need to park with it by increasing the cash reserve ratio. It also indicates the central bank’s willingness to control inflation at any cost—previously, it had been reluctant to raise its policy rate because this could have an adverse effect on economic growth.
/Content/Videos/2008-06-12/Tamal on RRP Hike_MINT_TV.flv
This is the third instance of RBI taking policy measures to contain inflation in the past two months. In April, it raised banks’ CRR by 75 basis points to 8.25% in stages. One basis point is one-hundredth of a percentage point.
Economists and money market analysts expect RBI to increase the interest rate again in July when it meets for a quarterly review of monetary policy because wholesale price-based inflation is expected to rise further on the back of the recent hike in fuel prices.
While lending rates of banks may go up, the rupee, which has lost more than 8% against the dollar since January, may strengthen as a higher interest rate may attract capital flows that have completely dried up. The Indian currency closed at 42.86/87 to a dollar on Wednesday before the new policy rate was announced.
Yields on the benchmark 10-year bonds which closed at 8.26% may rise 10 basis points and not more as the bond market has already factored in the hike.
“The hike has removed the uncertainties from the market,” said A. Prasanna, vice-president, ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds.
THE INDIAN REPO TRICK (Graphic)
Equity fund managers do not expect a huge impact on the stock market because the market has already discounted the rate increase.
“...that is why stocks were falling so fast,” said A. Balasubramaniam, chief investment officer, Birla Sun Life Mutual Fund, which has about Rs13,000 crore worth of assets under management.
The Bombay Stock Exchange benchmark Sensex has lost more than 9%—from 16,415.57 points to 14,889.25—in June. The index closed at 15,185.32 on Wednesday, up about 2% or 296.07 points.
M.B.N. Rao, chairman and managing director of Canara Bank and also chairman of the Indian Banks’ Association, the bankers’ body in the country said that the “outlook on inflation will decide whether medium and long-term interest rates will be hiked or not.”
Canara Bank will take a call on rates soon, he said. The asset liability committee of State Bank of India, the country’s largest lender, will meet on Friday to do so too.
Chanda Kochhar, joint managing director of ICICI Bank, said her bank would “monitor the impact of this hike and take a decision at an appropriate time.”
M.V. Nair, chairman of Union Bank of India, Meera Sanyal, country executive of ABN Amro India, and Romesh Sobti, managing director and chief executive officer of IndusInd Bank Ltd, too, said banks will have to raise their lending rates following the policy rate hike.
Economists expect RBI to now increase the reverse repo rate and CRR too to contain inflation.
“With the hike in fuel prices, inflation is likely to shoot up. Globally, for the central banks, the focus has shifted from growth to inflation and RBI is no exception,” said Abheek Barua, chief economist of HDFC Bank Ltd.