But Governor Rajan warns of rate hike if inflation does not subside

Reserve Bank Governor Raghuram Rajan on Wednesday sprang a surprise leaving key rates unchanged to back growth but warned that they may be hiked if inflation does not subside.

Expecting softening of vegetable prices and lower overall inflation going forward, the RBI maintained status quo on the repo rate at 7.75 per cent and cash reserve ratio (CRR) at 4 per cent. The move was cheered by the stock market. The Sensex soared to close 247.72 points higher at 20,859.86 on Wednesday.

The repo rate is the rate at which banks borrow from the RBI while CRR is the slice of deposits that banks have to compulsorily park with the RBI.

“If the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation...or if inflation, excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates,” Rajan said at a press conference after unveiling the Mid-Quarter Monetary Policy Review. The next review is due on January 28.

Deposit, lending rates

Wednesday’s policy move is unlikely to see banks change their lending and deposit rates. This will leave customers with little to cheer about. However, the decision will be come as a breather for industry and retail borrowers in particular as the markets had expected another 0.25 percentage point hike in the short-term lending rate that could have raised EMIs for home, auto and other loans.

After he took office in September, Rajan had hiked policy rates twice by 25 basis points each. Lauding the RBI’s decision to hold rates, India Inc on Wednesday said monetary policy alone was not the answer to tackling inflation and that the Government must initiate supply-side reforms and put in place better storage facilities to contain food prices.

“The RBI has demonstrated restraint and foresight to strike the right balance between inflation and growth,” CII Director-General Chandrajit Banerjee said.

Banks on watch mode

According to Bank of Baroda Chairman and Managing Director, S.S. Mundra, “It will be status quo (on deposit and lending rates) and we will wait-and-watch. Credit demand is subdued and liquidity is comfortable as of now.”

However, the BoB chief pointed out that if one of the two variables — liquidity or credit demand — changes, only then would the need arise to review the interest rates.

Explaining the rationale for not hiking the rate in the mid-quarter policy, Rajan said, “Recent readings suggest that both retail and wholesale inflation have increased mainly on account of food prices. Our own current readings from metros suggest a significant fall in vegetable prices at the wholesale and retail levels, which gives us reason to make this statement.”

The Governor said the RBI will not react to every spike in inflation that is temporary.

He however, said the decision not to hike policy rates should not be read as though the RBI is going soft on inflation.

“Current inflation is too high…there is merit in waiting for more data to reduce uncertainty,” he added.

Acknowledging the risks in waiting for more data, Rajan said the RBI will be vigilant.

(This article was published on December 18, 2013)
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