RBI hikes policy rates by another 25 basis points

RBI hikes policy rates by another 25 basis points

Mumbai: The Reserve Bank of India on Tuesday hiked its overnight lending and borrowing rates by 0.25% each, as it continued its long battle against high inflation.

The central bank has been one of the most aggressive regional central banks, having raised its key lending rate thirteen times since March 2010 to fight inflation.

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Also See | FULL TEXT : RBI Q2 review of monetary policy 2011-12 ( PDF )

RBI lifts rates, says may not need further hikes

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Several central banks across Asia and other developing regions have either cut interest rates or taken a breather, as worries about growth increase across the world. In its economic review released on Monday, RBI had indicated that it is increasingly aware of the fact that the Indian economy is losing momentum.

RBI hiked the repo rate to 8.5% and the reverse repo rate to 7.5% with immediate effect.

These are the rates at which the central bank pumps in or sucks out liquidity from the short-term money market. The policy moves are expected to ease inflation, the bank said.

Citing a slowing world economy and moderating domestic demand, RBI also lowered its forecast for economic growth in the current fiscal from 8% to 7.6% but retained its inflation forecast at 7%. “Of larger concern is the fact that even with the visible moderation in growth, inflation has persisted," RBI governor D. Subbarao said.

“But there are also other factors responsible for the moderation in growth, particularly for the significant slowdown in investment activity, such as policy and regulatory matters," the governor said.

In a significant reform move, RBI has deregulated the savings rate of banks with immediate effect. Banks are now free to determine their savings bank deposit interest rate but each bank has to offer a uniform interest rate on savings bank deposits up to Rs1 lakh, irrespective of the amount in the account within this limit.

For savings bank deposits over Rs1 lakh, a bank may provide differential rates of interest, if it so chooses. “However, there should not be any discrimination from customer to customer on interest rates for similar amount of deposit," the RBI said.

P. Sitaram, chief financial officer of IDBI Bank Ltd, said the deregulation will lead to a structural change in the existing form of savings accounts.

“The product will no more exist in the current form. It is likely to split into two types. One will act as some sort of a current account and the latter as a special bank specific product. We need to wait and see how this will exactly evolve," he said.

RBI, however, left the cash reserve ratio, or the amount at which banks have to park deposits with the apex bank for zero interest, unchanged at 6 %.

With Tuesday’s hike, the RBI has increased its effective policy rate 525 basis points (bps) since March, 2010 to fight inflation. One basis point is one hundredth of a percentage point.

A section of bankers and economists are not too optimistic about the ability of the central bank to check inflation, as they feel that successive rate hikes will be less effective without fiscal discipline.

Despite several rate hikes by the RBI to tame inflation, India’s wholesale price inflation continues to remain high, way beyond the central bank’s comfort level.

On the other hand, rate actions have helped bring down growth. For instance, industrial production growth has stayed below 10% in the last 10 months. It recorded a 4.1% growth in August.

Inflation stood at 9.72% in September, way above the central bank’s target for the fiscal. On Monday, releasing its macro economic and monetary developments report, the central bank had said that inflation remained “sticky" even as risks to growth have increased.

The market had already discounted a 25 bp hike in key rates. Neither the benchmark Sensex, the ten-year bond yield nor the rupee saw any major action in response to the central bank move.

Banks, however, said they are unlikely to pass on the rate hike immediately to the borrowers’ kitty given that loan demand is already poor in a slowing economy.

“Even with a 0.25% hike, we may wait for a month or so to watch the market prior to hiking the lending rate. The pass on may be only partial," S.S. Mundra, executive director at state-owned Union Bank of India told reporters on Monday on the sidelines of a press conference.

Analysts too agree to this view. “The transmission is likely to be a bit slower and banks are unlikely pass on the increase in policy to the customer immediately," Vaibhav Agarwal, vice-president (research) at Angel Broking Ltd. “Any further lending hike will happen to protect their profitability. Also banks have not hiked deposit rates much of late," Agarwal said.

During the customary pre-policy meetings, both the banks and companies had urged the central bank to take a pause, arguing that high interest rates have already begun to hurt growth.

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Following are highlights from the monetary policy statement:

Policy Measures

Repo rate raised by 25 bps to 8.50%

Reverse repo rate rises to 7.50%

Cash reserve ratio retained at 6%


Revises down its growth forecast for the current fiscal year ending in March to 7.6% from 8% with downward bias.

Retains end-March WPI inflation forecast at 7%

Retains FY12 money supply growth projection at 15.5%

Keeps 2011-12 credit growth projection at 18%

Policy Stance

Maintain an interest rate environment to contain inflation and anchor inflation expectations

Stimulate investment activity to support raising the trend growth

Manage liquidity to ensure that it remains in moderate deficit, consistent with effective monetary transmission

Inflation, Growth

Medium-term inflation risks in the economy “high"

Necessary to persist with anti-inflationary stance even as impact of past monetary actions unfolds

As inflation begins to decline, opportunity emerges for policy stance to consider growth risks

Changing policy stance when inflation high entails risk to credibility of RBI’s commitment to low, stable inflation

Food inflation likely to remain under pressure

Signs of demand moderation evident, although impact being felt more on investment side.

Elevated inflationary pressures expected to ease from December 2011, though uncertainties remain.

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Commentary ( Reuters )

Anubhuti Sahay, economist, Standard Chartered Bank, Mumbai:

“While the repo rate increase is in-line with expectation the statement is dovish as the Reserve Bank of India (RBI) has put a relatively low probability to another rate action in December (provided inflation does not deviate from their expected trajectory).

“Also the FY12 GDP growth projection has been revised downward from 8.0% to 7.6%. While RBI has still stated containing inflation and anchoring inflationary expectations as important, the focus is now shifting to stimulating investment/growth. Thus after a period of pause in interest rate, reversal in the interest rate cycle in 2012 will not surprise us."

Shakti Satapathy, economist, A.K Capital, Mumbai:

“The current rate hike is justified on account of inflation risk still persistent in the economy, coupled with depreciating rupee and fiscal slippage. Further the savings bank deregulation may prompt a rise in deposit growth leading to a shift from consumption demand towards investment demand in the mid to long term."

Radhika Rao, economist, Forecast PTE, Singapore:

“Onshore financial markets are rejoicing clear indications by the RBI that the end to the rate tightening cycle is in sight, as base effects prod the WPI prints lower at the turn of the year. Prima facie, post-policy comments still carry hawkish hues in our opinion as the central bank cites risks to credibility on any change in policy trajectory when inflation is still high.

“It is patently clear that RBI gives more weightage to domestic economic conditions and in light of today’s comments, odds for a rate hike in December still exists, especially if rupee depreciates further -- which in effect could unwind RBI’s anti-inflationary stance. Deregulating savings is a step in the right direction and should benefit end-consumers."

Indranil Pan, chief economist, Kotak Mahindra Bank, Mumbai:

“Clear direction from the RBI is now in place, that they are not looking at any more increase."

Arun Singh, Senior Economist, Dun & Bradstreet, Mumbai:

“Inflation has taken a bad shape for the economy. And if the central bank would have paused right now, there could have been a bubble formation somewhere in the economy.

“The RBI knows this and, therefore, taming inflation will remain its top priority. Hence, another 25 basis point rate hike in December should not be a surprise."

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Industry View

N. Shridhar, group director, Business Strategy & Finance, DB Realty

“The corporate margins would be under pressure given the increase in interest rates leading to a compression on spends in capex. For home buyers, this would result in an increase in outflow of EMI (equated monthly installments), which will lead to a compression in demand in new home purchases."

Sunil Sikka, president, Havells India

“So far, they have not been able to check inflation that remains unabated. They must look at some other means instead of just keep raising the repo rate. We all know it’s a demand dampener. I hope it is the last one."

Paban K Kataky, director, Exide Industries

“The industry is already reeling under high interest rates. Things will get even worse after this. Funding costs will rise as interest rates will have a spiralling effect on everything. In such a situation, the demand becomes lower, so your production goes down and costs go up. There will be pressure on profitability. Things are very difficult for the industry. The government seems to be thinking that only by increasing the rates they can bring down the inflation."

B. Hariharan, group finance director, Ballarpur Industries

“This might be the last rate hike. But corporates are unlikely to take any new investment decisions at these levels. They would rather wait for the rates to soften."

H.M.Bharuka, managing director, Kansai Nerolac

“We are confident that no further rate hikes will take place but worries about growth remain. The industry has been expecting a slowdown in the economy but RBI was not acknowledging it. Finally they have acknowledged there is a slowdown by revising down the growth forecast.

For the paints industry, the constant rate increases have severely affected demand as they have impacted the auto and housing industry. So we are hoping, if the rate rise cycle comes to an end with this, then demand can show signs of revival in a minimum of 6-10 months."

Anil Gupta, chairman and managing director, KEI Industries

“It’s a difficult scenario, our margins are getting hurt because of higher interest costs. On the other hand, our consumers like real estate firms are in a tight spot too. This is hurting demand for our products. Also, containing inflation by raising interest rates seems to be having no impact as the inflation is largely because of supply side issues."

Venu Srinivasan, chairman, TVS Motor Co Ltd

“The positive side is the language used by the RBI, indicating they will look at moderating. I think the government and the Reserve Bank are getting concerned that we can get into a period of high inflation and low growth. Still, at this point in time they could have put off the increase in my view, because the economy is likely to grow just above 7%.

The two wheeler industry has grown by 19% in the first six months and will probably grow 12-14% in the next six months. We are likely to end up with a 15% growth this year."

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Market Reaction

• India’s 10-year benchmark bond yield fell 6 basis points to 8.70% immediately after the central bank’s policy decision.

• The benchmark 5-year swap rate fell 7 basis points to 7.33%, while the 1-year swap rate dropped 2 bps to 8.17%.

• The main share index extended its rise to 1%, before turning negative.

• The partially convertible rupee was at 49.7000 per dollar from 49.6950.