A proactive move

In continuation of its pronounced objective of taming inflation, the RBI has raised the repo rates by 25 basis points to 8.25 per cent.

This is the twelfth occasion since March 2010 that the RBI has raised policy rates.

The RBI's decision is driven by concerns over the sovereign debt problems and deceleration of economic activity in Euro area, high unemployment and weak housing markets in the US, contraction of economic activities in Japan due to natural calamities and, above all, domestic challenges emanating from high food and non-food manufactured products' inflation and high crude oil prices.

The RBI has been employing monetary policy measures very carefully all along to fight inflationary pressures while ensuring that the country's growth prospect is not unduly hindered in the process, even in the short or medium term. The very fact that the central bank has increased the policy rates so may times in the last 18 months but only in small measures clearly speaks volumes of its best efforts in balancing the two basic macroeconomic fundamentals.

Proactive Stance

The RBI's decision to hike repo rate is influenced by inflation continuously remaining above the comfort zone of RBI with a high content of non-food manufactured products' inflation. Even the food inflation is near double-digit levels despite normal monsoon and incomplete pass-through of high global crude oil prices into domestic prices.

Weakening momentum in the growth in advanced economies and concerns over the longer time for recovery and its likely adverse effects on our country's exports have been reasons.

Considering all these factors, the RBI believes that there is an element of suppressed inflation, and hence its decision to hike repo rate can be aptly termed proactive.

Reaction

Consequent to the rate rise, the cost of funding is most likely to increase for the banking system. While the banks may not increase deposit rates immediately, they may like to raise hike base rates or BPLRs to give effect to the policy rate hike transmission, perhaps after a discussion at their ALCOs.

The enhanced lending rates may deter higher loan growth to yield the desired effects of policy rate hike to arrest demand pressures and, ultimately, to contain inflation.

(The author is the Managing Director and Chief Executive Officer of City Union Bank)

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