RBI hikes policy rates by 50 bps, raises inflation projection

RBI governor D. Subbarao (C) with Deputy Governors (L-R) H. R. Khan, K. C. Chakrabarty, Subir Gokarn and Anand Sinha before the RBI’s credit policy review meeting in Mumbai on Tuesday

RBI also raised the baseline projection for wholesale price index (WPI) based inflation for end-March 2012 from 6% with an upside bias to 7% but retained the economic growth target at 8%

The Reserve Bank of India (RBI) on Tuesday surprised the markets by raising its key policy rate by a more-than-expected half percentage point, continuing its fight against inflation that’s eroding the benefits of economic expansion in the world’s second-fastest growing major economy. The benchmark repurchase or repo rate, that at which RBI lends short-term funds to commercial banks, was raised to 8% from 7.5%, compared with expectations of a 25 basis point rise. The reverse repo rate, that at which RBI drains excess liquidity from the system, was raised to 7% from 6.5%. Shares tumbled and bond yields rose sharply to the highest level since May after the policy announcement. This is the 11th time since March 2010 that RBI has raised policy rates as part of its fight to control inflation. RBI also raised the baseline projection for inflation based on the wholesale price index (WPI) for end-March 2012 from 6% with an upside bias to 7% but retained the economic growth target at 8%. It revised the bank credit growth projection downwards from 19% to 18% for the current fiscal year. “Going forward, the monetary policy stance will depend on the evolving inflation trajectory, which in turn will be determined by trends in domestic growth and global commodity prices. A change in stance will be motivated by signs of a sustainable downturn in inflation,” RBI governor D. Subbarao said. The higher-than-expected increase in the repo rate will make money costlier for individual borrowers as well as corporations, analysts and bankers said. Shortly after the policy announcement, private sector lender Yes Bank Ltd increased its base rate, the minimum rate at which banks lend, by 50 basis points (bps) to 10.25%. It also increased the benchmark prime lending rate by a similar quantum. One bps is one-hundredth of a percentage point. Senior bankers said the latest round of rate increases will increase pressure on them to pass on the burden to customers. “Banks cannot afford to hold the rates as the cost of funds has increased substantially. However, banks will wait till next quarter to begin the rate hikes,” said Ramnath Pradeep, chairman and managing director of Corporation Bank. Borrowers are likely to have to pay more for loans. “One more round of hike in lending and deposit rates looks inevitable as the cost of funds at the current level is well beyond the absorption capacity of banks,” said Abhishek Kothari, research analyst with Mumbai-based brokerage Way2Wealth Brokers Pvt Ltd. “This can further hit the flow of credit and affect the asset quality in the system.” The apex bank said Tuesday’s moves, while reinforcing the cumulative impact of past actions on demand, will maintain the credibility of the monetary policy’s commitment toward controlling inflation. “In the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required,” the apex bank said. The Bombay Stock Exchange’s bellwether equity index, the Sensex, was down 292 points, or 1.55%, at 18,578.85 at 1:34 p.m. local time. Economists said the central bank’s monetary stance is likely to remain hawkish. “At this point, all major risks point towards inflation remaining on the higher side. Also, core inflation is fairly high compared to the long-term average of 4%,” said Gaurav kapur, vice president and senior economist, Royal Bank of Scotland India. “Fiscal consolidation is important from a perspective of managing inflation from the medium to long term. Given these factors, RBI’s monetary stance is likely to remain hawkish moving ahead.” The apex bank will continue to increase rates until inflationary pressures are lowered, said Rupa Rege Nitsure, chief economist at Bank of Baroda. “RBI has acknowledged that inflation is the real dampener on growth and they will be happy with a 7.5% growth and 7% inflation rather than 8.6% growth and 10% inflation. The price of money is still not high enough because demand continues to be strong,” Nitsure said. RBI said inflation will remain under pressure moving ahead and that reining in prices is imperative to sustaining growth. High non-food manufacturing inflation or core inflation, at 7.2%, is a major concern, RBI said. In the last six months, Indian banks have raised their loan rates by at least 150-200 bps to pass on the burden of the central bank’s successive rate hikes to customers in a bid to protect margins. High inflation has been a persistent worry for the Indian central bank as wholesale price inflation has been staying above its comfort level for quite sometime. It stood at 9.44% in June. On Monday, releasing its macroeconomic review, the apex bank had reiterated that inflation continues to be a major threat to the economy even though it acknowledged a moderation in growth in 2011-12. Further, the central bank said that taming inflation remains an “unfinished task” as price pressures persist.

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