Reserve Bank of India (RBI) governor Y.V. Reddy has served a surprise— not because he has raised interest rates but because of the extent of the raise. The repo rate has been pushed up by 50 basis points. And the cash reserve ratio has been raised by the same amount.
This move is surprising since it comes after a statement by Reddy on Monday that RBI would “take determined and calibrated” action to fight inflation. Tuesday’s action is more determined than calibrated.
We believe the move was overdue. Monetary policy has been too loose at a time when inflation has moved into double digits. Real interest rates are negative, which suggests that there is a case for further tightening.
The markets may pretend to be surprised. But there were enough signals from policymakers that monetary policy would be the first line of defence against high inflation. It is a matter of time before deposit and lending rates start to climb.