RBI hikes key rates 50 bps to fight inflation

In a surprise move, the Reserve Bank of India hiked its main policy rates by 50 basis points today in its first quarter review of its monetary policy.

Consequently, the repo rate is now at 8 per cent while the reverse repo rate is at 7 per cent. The marginal standing facility (which is at 100 bps above the repo rate) will be at 9 per cent. The rate hikes are the eleventh successive hike since March 2010.

The market had expected a 25 bps hike in this quarter because of inflationary conditions. However, bankers had appealed to the RBI last week to hold its hiking cycle because of a slight slack in credit growth and lower industrial output in May. The RBI didn't oblige.

Inflation worries

The RBI said today that the policy decision was based on two main considerations. First, demand had remained strong. Inflation has been higher than expected and non-food manufactured product inflation had been significantly higher than the average rate of 4 per cent seen in the last six years.

Second, while there were signs that growth was moderating in some interest sensitive sectors, the RBI made it clear that there is no evidence yet of a broad-based slowdown. Several indicators such as exports, imports, indirect tax collections, corporate sales and earnings and demand for bank credit show that demand was moderating but only gradually, the policy statement said.

The RBI is retaining its GDP projection at 8 per cent, made in its annual policy statement three months ago. It has revised upwards its WPI inflation target to 7 per cent from 6 per cent given earlier. It, however, hopes to contain inflation expectations to between 4 and 4.5 per cent to bring it closer in line with its medium-term target of 3 per cent.

The RBI has also revised downwards its credit growth target to 18 per cent from 19 per cent for this fiscal and also its M3 target to 15.5 per cent from 16 per cent.

The RBI Governor, Dr D. Subbarao, noted with some satisfaction that there had been strong transmission of policy rates. He said in his policy statement, "Taking cues from the monetary policy actions of the Reserve Bank, scheduled commercial banks have been raising their deposit and lending rates. Since March 2010, banks have raised their modal term deposit rate by 225 basis points. On the lending side, since July 2010, the modal Base Rate of banks has also increased by 225 basis points."

YES Bank hikes Base Rate

Private sector banks were first off the block in reacting to the latest hike. YES Bank has hiked its base rate and its PLR by 50 basis points. Its base rate will now be 10.25 per cent. YES Bank's PLR is at 19.5 percent.

Reacting to the 50 bps hike, Mr T.B. Kapali, Vice-President (Economic Research) at Shriram Group of Companies, Chennai, said, that the RBI had followed a policy of calibrated increases over the past year. "But an occasional acceleration was inevitable in the given circumstances and this move should be seen in that light," he said.

Mr Kapali pointed out that it was interesting that the Cash Reserve Ratio (CRR) had been left untouched during the past year. This was a signal from the central bank to the financial system and the borowers that it would not kill liquidity in order to contain inflation. Noting that CRR was a powerful inflation fighting tool, he pointed out that the Chinese central bank had used this a number of times in the last year.

The RBI’s unexpected decision led to a sharp decline of over 300 points in the Sensex to 18,570 after the policy was announced, although it had opened in positive terrain.

The Sensex was trading down 268 points at 18,602 at 12.40 p.m.

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