RBI hikes repo, reverse repo rates by 25 basis points
Moneylife Digital Team 25 October 2011

“Changing the policy stance when inflation is still far above the tolerance level entails risks to the credibility of the Reserve Bank’s commitment to low and stable inflation,” the apex bank said in its policy review document.

Continuing with its tight monetary policy stance, the Reserve Bank of India (RBI) in its quarterly policy review today, raised interest rates by 25 basis points (bps). Following the rate increase, the 13th since March 2010, the repo rate (the rate at which the RBI lends money to banks) now stands at 8.5%, and the reverse repo (the rate at which the RBI borrows from banks) rate has gone up to 7.5%. The central bank has, however, kept the cash reserve ratio (CRR) unchanged at 6%.

The series of rate hikes has cumulatively increased interest rates by 525bps in the last 18 months.

However, despite the RBI's tightening measures so far, the country's headline inflation was 9.72% in September, the 10th straight month where it has remained above 9 percent.

The RBI has also lowered the gross domestic product (GDP) growth projection to 7.6% from 8% in 2011-12. It added that inflation, which has been over the 9% mark, is expected to fall from December and has pegged it at 7% by March 2012.

In a major policy decision, governor D Subbarao also deregulated savings bank deposit rates with immediate effect.

"Changing the policy stance when inflation is still far above the tolerance level entails risks to the credibility of the Reserve Bank's commitment to low and stable inflation," the policy document said, even as it admits that growth momentum has slowed down.

Commenting on the rate hike, bankers opined that retail and corporate credit, including home and auto loans, are set to become costlier.

"Banks are likely to increase both lending and deposit rates following the RBI action. There could be a minimum 25bps rise in lending rates," Oriental Bank of Commerce executive director SC Sinha said.

Echoing Mr Sinha's views, IDBI Bank executive director RK Bansal said, "Lending rates would certainly go up on two counts-one, RBI has raised policy rates and second deregulation of deposit rates on savings bank accounts." G Chokkalingam, group CIO, Centrum Wealth Managers said, "This signals peaking out of the current interest rate cycle. Deregulation of savings bank account interest rate is positive for the old private sector banks like Karur Vysya Bank and large private sector banks like YES Bank, which have quite low CASA (current account and savings account) ratio."

According to Abraham Chacko, executive director, Federal Bank, "The 25bps hike in repo and reverse repo is in line with expectations. More importantly, there are indications that this is the last hike by the RBI for the year. A 25bps hike would not affect corporate borrowers much, but could have an adverse effect on retail borrowers, if the hike is passed on to them."  

A few players in the insurance industry also feel that further rate hikes may not be on the cards. Sandeep Nanda, chief investment officer, Bharti AXA Life Insurance, said: "The indication of a pause in the rates going forward has fulfilled hopes that the credit cycle has in all probability peaked. The likelihood of further rate hikes is relatively low keeping in view that inflation would decline beginning December 2011, that past monetary policy actions have started taking effect and developments in the global scenario have started affecting growth. I expect rate sensitive sectors to perform better henceforth.

"Given the current liquidity environment, the deregulation of savings account rates would likely move up the interest cost curve for the entire banking system and the end-borrowers. To that extent, the policy may lead to hikes in bank base rates, increase interest-rate volatility and also deal a blow to margins of banks with high savings deposits," Mr Nanda added.

Rajiv Kumar, secretary general of FICCI said, "A clearer statement on preventing a rapid depreciation of the rupee by the governor would have been especially welcome. It is heartening to see that the RBI is finally giving some importance to supply-side measures and talking about the need for raising the potential rate of growth through the implementation of structural reforms.

Mr Kumar added, "The announcement of a 1% subsidy on home loans by the government which came almost at the same time at the Credit Policy announcement will surely help in arresting the further decline in demand for new housing. Overall, FICCI is relieved to see a halt in the cycle of interest rate increases and urges the government to take further steps that will restore investors' confidence in coming months." However, FICCI feels that the inflation rate of 7% projected by the apex bank at the end of March 2012 could possibly be an underestimation. "This is based almost entirely on the expectation that the higher base effect will bring down the inflation rate in the coming months," said the FICCI statement.

1 decade ago
The Harward educated economists in our Govt fail to see what is obvious. When the demand outstrips supply, prices will shoot up. Instead of managing supply-side, the Govt is adding fuel to the fire. High support prices for food grains announced by the govt with an eye on elections is another reason for high inflation.
1 decade ago
I dont think the interest rte hikes are being very effective. Whats required is some structural changes in the way our economy functions.

1. The governments, Central as well as States, need to stop wasting public money in the name of NREGA, Right to Education, Right to Food, etc as most of the monies of such good causes are swindled by the politician- bureaucrat- businessmen nexus. Also instead of giving people fish, they should be taught how to fish so that they can stand on their feet and take care of themselves. The present policies are only populist in nature and does not do anything to add to the abilities of those whom these policies purport to benefit.

2. The tax burden on the middle class should be lowered by bringing capital gains, dividend income and farm income to the taxation mould. There can probably be a floor beyond which the maximum marginal rate should be applied. Why should a rich farmer in India driving a BMW and having a palace to live in be given tax exemption?

3. Farming and associated activities like procurement, distribution, etc should be opened up for private or public private partnerships. Lack of storage facilities and absence of large scale organized retail causes price distortions and leads to supernormal profits to the middlemen harming both the farmer community as well as the consumers.

4. The tax laws across the country should be simplified with reasonable exemption levels and thresholds. Once that has been we should publicly shame people who are found to be evading taxes.

5. The Reserve Bank of India should make it mandatory for businesses to pay and accept monies by way of electronic medium above a certain threshold. This can be by way of cards and the Government can extend certain tax benefits to the business community. This would ensure that the black economy migrates to the real economy.

6. Taxation of petroleum or energy products should be rationalized as taxes form more than 50 percent of the retail price paid in India. This would boost production and productivity.

7. Subsidies on fertilizers, electricity, and tax benefits should be replaced by market determined pricing. Government should give cash susidy to the needy by way of an account transfer.

8. Private Equity players, NRIs and foreigners should not be allowed to invest in land and apartments beyond a reasonable level. They should not be allowed to hoard real estate as if they are equity shares. This would ensure that property is sold to the needy only. Any resident found to own collectively as a family more than 2 or 3 houses cannot keep it empty. It has to be rented in order to maintain realistic rentals in the country.

9. The Government should invest in building more cities and urban areas like Mumbai so that pressure on existing cities reduce and people do not need to migrate to the existing over crowded cities.

These measures would ensure that the inflationary pressure facing the economy and the citizens would go down.
1 decade ago
WELL DONE,RBI, although the hike would have been more effective if at least 50 basis points (0.50%).
The deregulation of Savings Bank Interest Rates is also a welcome move.
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