RBI takes inflation head-on; raises key rates 50 basis points

The Reserve Bank of India abandoned its ‘calibrated, baby-step approach' to fighting inflation. Instead, it took a ‘large-step' on Tuesday, hiking by 50 basis points the key rate at which banks draw liquidity from it.

Following the hike, the repo rate has moved up to 7.25 per cent (6.50 per cent earlier) with immediate effect.

The increase in this operating policy rate comes at a time when current elevated rates of inflation (9 per cent at March-end 2011) are posing significant risks to growth. Bringing inflation down, even at the cost of some growth in the short-run, should take precedence, the RBI said.

According to the new operating procedure for monetary policy, the interest that banks earn for parking surplus liquidity with the RBI (at a 100 basis points spread below the repo rate) too has gone up to 6.25 per cent (the reverse repo rate earlier was 5.75 per cent).

Defending the move, the RBI Governor, Dr D. Subbarao, said: “In the long-term, inflation is inimical to growth…. We need to bring inflation down in order to sustain medium term growth even if that means sacrificing some growth in the short-term.”

In a move that will bring some cheer to savers reeling under negative inflation-adjusted returns, the central bank has upped the savings bank (SB) deposit rate to 4 per cent (3.5 per cent earlier) with immediate effect. The SB rate was last hiked in 2003 from 3 per cent to 3.5 per cent.

The twin-moves by the RBI could prove a double whammy for banks as their margins could come under pressure.

With resources getting dearer, banks are gearing up to hike lending rates by 50-100 basis points. However, in order to protect their margins, they may not immediately raise deposit rates.

IDBI Bank ups rates

First off the mark was IDBI Bank that within hours of RBI action hiked lending and deposit rates by up to 50 bps.

Said Ms Chanda Kochhar, Managing Director and CEO, ICICI Bank: “A large part of the rate increases will have to be passed on in the form of increase in lending rates, as most banks will try to maintain margins. The impact could be 50-100 basis points. It will depend on how much banks have already passed on.''

Banks will wait and watch the situation before taking any decision on deposit rates, said Mr K. R. Kamath, Chairman and Managing Director of Punjab National Bank. “We are entering the so called ‘off season'. If there is no credit pick up immediately and if there is no reason for banks to aim for unduly higher deposit growth, deposit rates may not go up immediately,'' he said.

The aim of RBI's strategy this year is to check inflation by restraining demand, navigating a soft landing, and fostering conditions for sustained growth in an environment of price stability.

GDP growth

The RBI has moderated its GDP growth projection for FY2012 to around 8 per cent, from 8.6 per cent in FY2011.

The moderation in growth is because agriculture growth is likely to revert to its trend growth from the higher base last year and the pace of industrial activity is slowing mainly due to the impact of past monetary policy actions and high input prices. Further, external demand too may slow if global recovery slackens.

INFLATION

The RBI's baseline projection for the wholesale price index based inflation for March-end 2012 has been placed at 6 per cent with an upward bias. Inflation, the RBI said, is expected to remain at an elevated level in the first half of the year due to expected pass-through of increase in international petroleum prices to domestic prices and continued pass-through of high input prices into manufactured products.

“…RBI's current priority is inflation. Over the year we expect to be preoccupied with inflation concerns and try to ensure that inflation comes down to the projected level,” the Governor said.

Hike in SB rate

The SB rate has been at 3.5 per cent since 2003. Given the differential that had emerged between this rate and all the other rates, particularly in this upward cycle, an adjustment was necessary, said the RBI Deputy Governor, Dr Subir Gokarn. “So, this is not a signal about deregulation. Incidentally, the hike may have monetary impact. But that is just incidental,”

“The SB interest rate hike is not to pressure banks……We don't want to destabilise the market. We want to be sure that it contributes to financial inclusion. But this (today's hike in SB rate) is no indication of a financial decision,” said Dr Subbarao.

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