RBI hiked key policy rates by 25 bps to control inflation

The Reserve Bank of India (RBI) has hiked key policy rates — the repo and the reverse repo a month ahead of its next quarterly review of monetary policy to control inflation and to anchor inflationary expectations. RBI has raised repo rates by 25 basis points each. After this raise now the repo or the rate at which banks borrow from the RBI is increased by 5.50% and the reverse repo (the rate at which RBI sucks up excess liquidity from the banking system) is at 4%.

Finance Minister Pranab Mukherjee while supporting the rate hike has called it as desirable. He said “These measures are desirable given that food inflation has risen and credit situation is tight... It is good that RBI has not raised CRR.”

However RBI was relived from the fact that in recent months the economic recovery is strengthening with the manufacturing sector showing increasing growth, but the central bank is worried about rising inflation. In May, the wholesale price index based inflation has increased to 10.2% which is up from 9.6 per cent in April. The RBI said in a statement explaining the rationale for the rate hike, “Food price inflation and consumer price inflation remain at elevated levels.”

Jahangir Aziz, chief economist at JP Morgan said, “This policy action was long over due. I think to sustain economic growth of 8 per cent and above, we should see more of such rate hikes in the coming months. I expect RBI to raise key interest rates again by 25 bps on the day of the monetary policy review on July 27”.

On the other hand bankers say they don’t see any reason for lending rates to move up. SBI’s Deputy Managing Director and Head of Treasury, Anjan Barua, told an agency “We don't expect upward pressure on lending, deposit rates as credit is still not picking up. We expect liquidity to improve substantially in July. I don't expect a major impact of the rate hike on government bonds and OIS on Monday.”

However many bankers were expecting such mid-cycle policy move from RBI much earlier when the banking system was struggling with a liquidity crunch. “It was considered inadvisable to raise the policy rates,” the RBI said, the credit shortage was a result of sudden increase in government cash balances because of huge realization from 3G spectrum and broadband wireless access auction.

Rupa Rege-Nitsure, chief economist at the Bank of Baroda said, “There is enough empirical evidence that the aggregate demand has sharply risen in sensitive sectors like consumer durables and commercial real estate. We have also seen a continuous rise in non-food inflation. Salaries in the private and corporate sector have risen the HRA in consumer price index has risen. All these factors have the potential to stoke inflation further. Therefore, we expect RBI to raise key interest rates by 75 basis points in this financial year. We can expect a 25 bps rise on July 27”.

C Rangarajan, Chairman, Prime Minister’s Economic Advisory Council said RBI reviewed its policy rates a month earlier due to increased inflationary pressure on the economy. “I expect another round of rate hike in the July policy review,” he told a news agency. This month on 27th RBI will be announcing its next quarterly policy review