RBI raises key rate, reserve requirement

RBI raises key rate, reserve requirement
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First Published: Wed, Jun 25 2008. 12 14 AM IST

Updated: Wed, Jun 25 2008. 07 30 PM IST
Consumers and companies looking for loans will likely find credit expensive and scarce, and India’s economic growth could moderate after the Reserve Bank of India (RBI) on Tuesday raised a key lending rate by half a percentage point to 8.5% and enhanced the quantum of reserves commercial banks need to keep with it by raising the cash reserve ratio (CRR) to 8.75%.
The central bank’s act was prompted by the need to control inflation which, as measured by wholesale prices, touched a 13-year high of 11.05% for the week ended 11 June.
The lending rate, the short-term repo rate or the rate at which RBI infuses liquidity into the banking system, has gone up to 8.5% and CRR will rise to 8.75% in two stages on 5 July and 19 July. The two-phase CRR hike will stamp out more than Rs17,000 crore of credit from the system.
Bankers were expecting an increase in policy rate as well as CRR but the quantum has surprised them. Banks are expected to raise their lending as well as deposit rates immediately, raising the cost of money for corporations as well as consumers.
The yield on 10-year benchmark government bonds that closed at 8.56% on Tuesday is expected to rise to 8.8-8.9%. The stock market will also bear the brunt of the tight money policy and the Sensex, the Bombay Stock Exchange’s benchmark index that already breached the 14,000-point level on Tuesday, will go down further.
The RBI’s announcement came late in the evening, hours after the markets closed. The central bank admitted that it is indeed a “painful” action but said it “has to be viewed in the context of the new reality of high and volatile energy prices”, which is not a temporary phenomenon any longer.
This is the fourth such action by RBI in the past two months. On 11 June, RBI raised the key lending rate by a quarter of a percentage point to 8% after leaving the rate untouched for the more than a year. In April, it raised banks’ CRR by 75 basis points in stages. One basis point is one-hundredth of a percentage point.
By raising its policy rate as well as CRR, RBI wants to dampen consumer demand that has been behind soaring inflation.
“It is important to recognise that an adjustment of overall aggregate demand on an economy-wide basis is warranted to ensure that generalised instability does not develop and erode the hard-earned gains in terms of both outcomes of and positive sentiments on India’s growth momentum,” the central bank said.
According to Abheek Barua, chief economist, HDFC Bank Ltd, RBI’s action will have a negative impact on growth of the Indian economy, “which might slow to 7.5%”.
“I am not surprised by the rate hike but I am not very sure whether this is the last of the rate hikes or more hikes are on the cards,” said Nitin Jain who heads ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds.
Bankers and bond dealers said the hike in rate as well as CRR will impact the market as the liquidity situation is already very tight with RBI selling dollars almost every day in the foreign exchange market to “defend the local currency”.
“It is not allowing the rupee to go below the 43 level against a dollar,” said a foreign exchange dealer, who did not wish to be named. Defending the rupee is also one way of fighting inflation as a stronger local currency brings down the cost of imports.
“Market was expecting a rate hike by the RBI, but probably not as much and certainly not in both repo and CRR at the same time. We will definitely see another round of selling tomorrow in interest rates-specific sectors such as banking, real estate and auto,” Gaurav Dua, head of research at Sharekhan Ltd, said.
“Banks have no other way than to raise the interest rates now,” said Bank of Baroda’s chief economist Rupa Rege Nitsure. “We expect banks to raise lending rates by 50 basis points. There could be spike in the yield curve and the 10-year yield is expected to touch 8.8-8.9%. We will also have to review rates,’’ said Barua.
Private sector banks are expected to hike lending rates across retail assets, including home loans, by 25-50 basis points. Lending rates for personal loans and auto and commercial vehicles segment are expected to go up by one full percentage point.
“Interest rates are a function of cost of funds. If the cost of funds move up, any bank will have to review rates,” said a senior official of ICICI Bank Ltd, India’s largest private sector lender.
“With the RBI move, rates are expected to harden by 50 basis point to 75 basis points,” said a senior official of HDFC Ltd, India’s oldest mortgage player. “The CRR hike will dry up the liquidity from the market and make it difficult for companies to raise money for expansion plans,” says Sheshagiri Rao, director, finance, JSW Steel Ltd. RBI’s statement hinted at more monetary tightening if the inflation rate remained high.
Ankur Relia contributed to this story.
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First Published: Wed, Jun 25 2008. 12 14 AM IST
More Topics: RBI | Interest rates | CRR | Repo rate | Inflation |