RBI raises rates by 50 bps; revises WPI inflation outlook upwards to 7%
Moneylife Digital Team 26 July 2011

Governor says there is need to persevere with anti-inflationary stance. Bond yields sharply up, while stocks drop 

The Reserve Bank of India (RBI) today raised interest rates by a higher-than-expected 50 basis points, indicating the seriousness of the fight against high inflation, despite slowing growth.

The central bank said it was increasing the repo rate at which it lends to banks to 8% from the previous 7.5%, and the reverse repo rate, to 7% from 6.5%. This is more than the 25 basis points increase that the market was expecting. However, the cash reserve ratio (CRR) has been left unchanged at 6%.

The indices slid immediately after the announcement with the BSE Sensex down by over 300 points (or 1.5%) and the S&P CNX Nifty losing nearly 100 points (or about 1.7%).

This is the 11th rate increase by the RBI since March 2010, which is seen as the most aggressive among central banks in fighting inflation.

"RBI continues to maintain its hawkish stance towards inflation and only signs of sustainable downturn in inflation would result in change in RBI's stance, which indicates that pause in rate hikes is not in sight and will clearly depend on the inflation trajectory," opined Abhijit Majumder, senior research analyst-institutional equities, Prabhudas Lilladher.

The wholesale price index inflation was at 9.44% in June, more than double the RBI's comfort level, and the fear is that high prices could persist through the end of the year.

The RBI also revised upwards its outlook for wholesale inflation for the current year to March 2012 to 7% from the earlier 6%.

RBI governor D Subbarao said in his policy review statement, "Considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance."

But the central bank stuck with its forecast for economic growth in the current year at around 8%, saying that while some interest-rate sensitive sectors have shown signs of moderating, "there is no evidence of a sharp or broad-based slowdown as yet".

"RBI's announcement of 50 basis points increase in repo rate comes as a major disappointment to the industry. With the growth momentum already under pressure, this move will further hurt the future prospects. Even the projected growth rate of 8% for the year 2011-12 now looks difficult to achieve" said Dr Rajiv Kumar, secretary general, FICCI.

Analysts widely expected the RBI to raise rates by about 25 basis points, while some believed there would be a pause in the tightening cycle due to signs of slowing growth and global uncertainty. Latest industrial output and manufacturing numbers were the worst in nine months and January-March quarter growth was a worse-than-expected 7.8%.

"The RBI's action to raise policy rate by 50 bps against market expectation of 25 bps in part reflects its desire to send a strong anti-inflationary message to market participants and in part reflects front loading of rate hikes. We expect another 25 bps rate hike and a pause thereafter to gauge the evolving growth-inflationary dynamic; however, policy easing is not on the cards yet. While, inflation will ease in the second half of the fiscal, in part due to base effect, full year inflation will average over 8%. While there have been signs of growth decelerating, we do not expect an abrupt deceleration in growth. We maintain our full year FY11-12 GDP growth estimate of 7.6%, down from 8.5% in FY10-11," Ashutosh Datar economist at IIFL said while commenting on the RBI's rate hike.

The RBI governor said today's measures are expected to "maintain the credibility of the commitment of monetary policy to controlling inflation". They will also "reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required."

ranjan dutta gupta
1 decade ago
If RBI is in the opinion that there is a plenty of money in the hands of salaried person and that is creating hugh demand.Then RBI should consult Finance Ministry to raise the limit of investment under Section 80C to at least Rs.3 lakhs so that all extra money should go to investments and locked in for few years.It will drastically bring down the demand quotient.
ranjan dutta gupta
1 decade ago
It is not correct to say that low interest regime will bring about the debt crisis.The crisis in USA is a systematic financial fault which occured due to over leveraging on signle debt component that is called securised debt paper.What RBI is doing at present is not at all in the right direction.RBI wants to tame inflation by raising repo and reverse repo rate.This move will hamper the industrial output.Infrastructural progress,will affect, real estate,construction,car and housing loan and drag down the GDP.It is an enigma to see that RBI is administering same medicine on a patient for last 16 months but there is no improvement in the health of patient.Then why RBI stubbornly sticking to the same medicine.Is it the right way to tackle a problem of an economy.The inflation is led by increase in commodity prices and supply side contraint.Demand is very natural to stay because the population of the country is increasing.Focus should be made on supply side control and growth.The need of the hour is to relax the interest rate and just concentrate on high growth of Industry and agriculture so that there should be ample supply and if the supply is more than the demand then automatically prices will fall and consequently inflation will fall.
1 decade ago
You have only to look at the huge Debt Crisis of USA to see what low-interest regime will lead a country to. There is a glitter of prosperity on the surface but below is a yawning black hole of ever-increasing debt.
1 decade ago
The 0.50% interest hike by RBI is a step in the right direction. Till now it has been taking only 'baby steps'. Now it is more decisive.
Rajiv Chawla
1 decade ago
With every 1% increase in interest rates, net profit of SMEs come down by about 20%. For every Rs.1 crore of credit, SMEs will pay almost Rs.3.5 lac more as interest this year as compared to 2009-10.

What govt. needs to do is to remove the supply side constraints for longterm cooling of inflation. This would happen only if production & supply is incentivized and hurdles & bottlenecks removed.

For our evergrowing nation of 1.2 billion people with inclusive development and benefit of expanding economy percolating to the grass root levels, which is essential and 100% welcome and must be encouraged rather than checked, a different approach is called for.

Blanket increase in interest rates affect all sectors- priority as well as others, from agriculture, housing, micro & small, exports to the largest of corporates. Govt. should rather look at different sectors on the basis of their growth rate and priority assessment. For example, it's time to withdraw economic stimulus of concessional excise duty of 10% against the normal 14% to sectors like white goods, particularly A.Cs & other luxury segments like toiletries, cosmetics, high-end fittings, music systems, large TV screens etc. to luxury segment automobiles, specially the diesel driven cars & SUVs.

I believe that priority sectors & BPL need to be protected from blanket interest rate hikes. Inflation be checked though demand cut in non-priority and luxury segments, Excise Duty normalisation in these areas be looked into, supply side be incentivised by protecting capacity building through CAPEX and or invest allowance route, Diesel cars & SUVs pay higher Excise Duties to offset diesel subsidies, other measures to check inflation while protecting the priority and weaker sections be introduced.

Otherwise, all we'll get in another quarter may be the 12th increase in interest rates, and a different category of poverty virus striking the middle-class and Micro & Small Enterprises.
ranjan dutta gupta
1 decade ago
Higher production in manufacturing and agriculture sector can only contain inflation.It is not the right way to tackle inflation just by increasing rate.RBI should understand that higher rate of interest will restrict companies to take loan either it is home loan, car loan or working capital loan or cash credit loan or term loan.If that will happen then automatically growth will suffer.It is not the game of GDP numbers.Slow growth will compel companies to reduce production. Reduced production will at the first stage will increase production cost.Then secondly low quantity of production will again create pressure of inflation.Rather opposite should happen RBI should reduce interest so that Bank can lend for more production and huge quantity of production will supersede the demand and price will fall.The commodity price control cannot happen because it is a internation factor and so RBI has no tool to control it.
1 decade ago
This is nothing but Voodoo economics - mindlessly propitiating the inflationary deity by offering it the great "raise-the-interest-rate" sacrifice. RBI is leaving no stone unturned in its quest to punish and restrain the productive sectors in Indian economy that can actually counter the inflationary pressures through greater production and exports. RBI should instead have reduced the interest rates drastically and seen the dramatic positive impact on the economy.
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