‘Owlish’ RBI hikes repo rate by 25 bps on inflation worry

The Reserve Bank of India sprang a surprise on Tuesday by increasing the interest rate banks pay to borrow short-term funds to 8 per cent from 7.75 per cent.

Despite the economic slowdown getting increasingly worrisome, the central bank chose to increase interest rates to tame rising prices.

RBI Governor Raghuram Rajan emphasised that the best way to create sustainable growth was by bringing down inflation.

“Elevated levels of inflation erode household budgets and constrict the purchasing power of consumers. This, in turn, discourages investment and weakens growth…” Rajan said in his interaction with the media, after announcing the third-quarter review of monetary policy.

To a specific question as to why the policy stance is hawkish while its guidance dovish, Rajan said his deputy, Urjit Patel, referred to the central bank as being neither a hawk nor a dove but an ‘owl’, signifying wisdom and alertness, when it comes to monetary policy formulation.

Bankers, economists and market players were expecting the RBI to maintain the status quo in view of the significant decline in inflation in December and the weak state of the economy.

Following the RBI’s rate action, banks may up deposit rates a tad, mostly at the short-end. Simultaneously, to protect their margins, they may nudge the spread they charge over the base rate (the minimum lending rate below which banks cannot lend) upwards for select segments.

Equity market players took the rate hike decision in their stride, with the benchmark BSE Sensex closing the day just 0.12 per cent (or 23.94 points) lower at 20,683.51 over the previous close.

The rupee closed 60 paise stronger at 62.50/dollar against the previous close of 63.10 on expectation that the rate hike would attract foreign exchange inflows.

Since taking charge of the RBI last September, Rajan has upped the repo rate (the rate at which banks borrow short-term funds from the central bank) thrice by 25 basis points each. One basis point is equal to one-hundredth of a percentage point.

The RBI maintained the status quo in its mid-quarter review of the monetary policy last month.

The Governor observed that the RBI’s baseline inflation projections for the October-December 2013 period indicate that over the ensuing 12-month horizon, and with an unchanged policy stance, there are upside risks to the central forecast of 8 per cent.

Hence, an increase in the policy rate is needed to set the economy securely on the recommended dis-inflationary path (CPI inflation below 8 per cent by January 2015 and below 6 per cent by January 2016, as suggested by the Urjit Patel committee).

The RBI said that further policy tightening in the near term is not anticipated at this juncture if the dis-inflationary process evolves according to the baseline projection.

GDP projection In its third-quarter review of macroeconomic and monetary developments document, which was released along with the policy, the RBI has assessed that growth in 2013-14 is likely to fall somewhat short of its earlier projection of 5 per cent.

However, a moderate recovery (5-6 per cent growth) is likely in the next fiscal year with support from rural demand, a pick-up in exports and improved investment demand.

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