Unrelenting on inflation, RBI ups key rates by 25 bps

The cup of woes for bank borrowers runneth over. Loans to segments such as home, auto, SME and large corporates could become dearer as the Reserve Bank of India on Friday hiked its short-term signalling rate to staunch surging price pressures in the economy.

In its mid-quarter review of the monetary policy for 2011-12, the central bank upped the interest rate at which it infuses liquidity into the banking system (the repo rate) by 0.25 percentage points (or 25 basis points or bps) from 8 per cent to 8.25 per cent. Following the hike in the repo rate, the reverse repo rate (the interest rate at which banks park surplus liquidity with the RBI) has got adjusted upwards from 7 per cent to 7.25 per cent.

This is the 12th time in the last 18 months that the RBI has hiked its short-term interest rates to dampen inflationary pressures. “Inflation remains high, generalised and much above the comfort zone of the RBI…In recent weeks, as a result of global risk aversion, the rupee has depreciated, which may have adverse implications for inflation,” the RBI said, in its review.

In the current scenario, with prices looking to be high for the next few months, rising inflationary expectations remain a key risk, making it imperative to persevere with the current anti-inflationary stance, the RBI said.

But India Inc was disappointed, with Dr Rajiv Kumar, Secretary-General, Federation of Indian Chambers of Commerce and Industry, saying: “When a cumulative rate hike of 325 basis points since March 2010 could not control inflation, how will another 25 basis point hike deliver? It is ironic that the RBI is now clearly banking for inflation rates to start declining toward the latter part of the current fiscal, based purely on base effect.”

Base rates up

Borrowing from banks has become costly due to successive hikes in the repo rate. This is underscored by the fact that since July 1, 2010, when the new benchmark rate for pricing loans came into effect, Base Rates have increased by 0.75 to 3.75 percentage points. Currently, the average Base Rate of banks is 10.75 per cent. Banks cannot lend below their Base Rate.

The increase in the repo rates, however, has had a beneficial impact for those saving with banks. Fixed deposit rates have been increased by 0.25-5.50 pp (for different maturities) since July 1, 2010, according to RBI data.

“An increase in interest rates is a function of liquidity and credit demand. Right now liquidity is comfortable and demand is sluggish. So, I don't see any immediate need to hike rates. But incremental credit demand could come in due to festive season demand, at which point banks could raise interest rates,” said Mr M. D. Mallya, Chairman, Indian Banks' Association, and CMD, Bank of Baroda.

‘Difficult call for banks'

Mr S. S. Mundra, Executive Director, Union Bank of India, said the past rate hikes have translated into corresponding increases by banks, though with a lag effect. However, this time around it will be a difficult call for banks to take because it is hurting some segments of borrowers.

Instead of raising their Base Rates, banks may up the margins charged over and above the Base Rates. “Increasing the Base Rate impacts all borrowers but margins give us the flexibility to target different segments of consumers,” explained Mr Mundra.

More hikes likely

That the RBI may continue with its rate hikes to tame inflation is underscored by its statement to the effect that “A premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions. It is, therefore, imperative to persist with the current anti-inflationary stance.”

The RBI assessed that the latest increase in the price of petrol of by Rs 3.14 a litre will have a direct impact of seven basis points to the wholesale price index-based inflation, in addition to indirect impact with a lag.

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