Hawkish RBI hikes key rates by 50 bps

Borrowers will feel the heat of rising interest rates as the Reserve Bank of India raised key short-term rates by a surprisingly strong 50 basis points.

The repo rate (the interest rate at which the RBI injects liquidity into the banking system) has been raised to 8 per cent from 7.5 per cent in view of the strong inflationary pressures.

The RBI Governor, Dr D Subbarao, observed that as long as inflation persists there will be no significant change in the central bank's stance.

The RBI, it appears, wants the Government to play its part in fighting inflation. The Governor said one of the expected outcomes of the rate hike is to reinforce the point that in the absence of complementary policy responses on demand and supply sides, stronger monetary policy actions are required.

The 50 basis points hike was totally unexpected as bankers and economists were preparing for only a 25 basis points hike in the repo rate in view of moderation in economic activity.

The reverse repo rate (the interest that banks earn on surplus liquidity parked with the RBI) has automatically got adjusted upwards to 7 per cent.

“Considering the persistence of inflation above the comfort level (4-4.5 per cent) of the Reserve Bank, and based on the premise that high inflation is inimical to long-term growth, the Reserve Bank has persevered with its anti-inflationary stance in 2011-12,” said Dr Subbarao.

The direct and indirect impact of the increase in administered petroleum product prices in June 2011; the increase in minimum support prices for some agricultural commodities; and the pass through of higher commodity prices into more generalised inflation are adding to inflation pressures.

“I want to reassure all of you that growth is never far away from our policy radar screen. We are always concerned about it. But we have to weigh the balance between growth and inflation,” said Dr Subbarao.

Since March 2010, the RBI has tightened policy rates 11 times (including the latest hike). Cumulatively, the repo and the reverse repo rates have been upped by 325 and 375 basis points respectively.

Borrowers to feel the pinch

Banks plan to pass on the latest hike in interest rates to their borrowers. At the same time, fixed deposits at the short-end — up to one year — could fetch more in view of the RBI's move.

Bankers, in their feedback to the RBI on its policy action, said their response is going to be more rapid than in the past. They pointed out that assets, especially in some interest-rate-sensitive sectors such as home loans, auto loans and real estate, might come under stress.

“Today's policy enunciation gave us the feeling that RBI is determined to win the war against inflation and it will do whatever it takes. The RBI is focused on reducing or containing consumption. They would like consumption to come down in targeted sectors. And they have only one instrument that is, interest rates, to target so many objectives,” said Mr Pratip Chaudhuri, Chairman, State Bank of India.

Inflation and GDP

Inflation projection for March 2012 has been revised upwards from 6 per cent with an upside bias to 7 per cent. The RBI has retained the baseline projection for real GDP growth at 8 per cent.

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