In an attempt to check the rising inflation and asset prices, the Reserve Bank of India (RBI) on Tuesday further increased its short-term indicative rates (repo and Reverse repo) by 25 basis points, while resorted to tame the rising prices in the housing sector by increasing the risk weight for residential housing loans of Rs.75 lakh and above to 125 per cent.

The repo rate has been raised to 6.25 per cent and the reverse repo rate to 5.25 per cent. The Cash Reserve Ratio has been left unchanged at 6 per cent.

With this increase, since the RBI had started reversing the monetary policy stance in March, the repo rate has been raised by 150 basis points and the reverse repo rate by 200 basis points.

“Inflation and inflationary expectations remain high as both demand-side and supply-side factors are at play. Given the spread and persistence of inflation, demand-side inflationary pressures need to be contained and inflationary expectations anchored,” said RBI Governor D. Subbarao while addressing a press conference after meeting bankers here on its review of half yearly Monetary Policy 2010-11.

“Even though a liquidity deficit is consistent with our anti-inflation stance, it needs to be contained within a reasonable limit to ensure that economic activity is not disrupted,” Dr. Subbarao added. However, he said, domestic growth drivers were robust which should help absorb a large extent the negative impact of any slowdown in global recovery.

Taking into account the good performance of the agriculture sector, and a range of indicators of industrial production and service sector activity, the baseline projection of real GDP growth for 2010-11, for policy purposes, is retained at 8.5 per cent.

Food inflation has not shown the expected post-monsoon moderation and has remained persistently elevated for over a year now, reflecting in part the structural demand-supply mismatches in several commodities. This has elevated inflation expectations.

The risks of expectations spilling over into prices of other commodities are significant when the economy is growing close to trend. “That could potentially offset the recent moderation.”

The RBI made a baseline projection of WPI inflation of 6 per cent for March 2011 under the old series of WPI. The baseline projection of WPI inflation for March 2011 has been placed at 5.5 per cent under the new series. This is equivalent to 6 per cent under the old series. Effectively, this means that the RBI's inflation projection remains unchanged from that made in its July 2010 review.

Tight liquidity

The present tight liquidity is a result of both structural and frictional factors. On the structural side, the deposit growth rate of the banking system has been sluggish even as the credit growth improved. On the frictional side, government cash balances had built up as a result of more than anticipated tax receipts. On top of it, there were large capital outflows on account of refund of over-subscription of Coal India IPO.

The RBI Governor pointed out the expected outcome from its monetary stance: Sustain the anti-inflationary thrust of recent monetary actions and outcomes in the face of persistent inflation risks; rein in rising inflationary expectations which may be aggravated by the structural nature of food price increases; and be moderate enough not to disrupt growth.

However, he said “we will take action as warranted with a view to mitigating any potentially disruptive effects of lumpy and volatile capital flows and sharp movements in domestic liquidity conditions, consistent with the broad objectives of price and output stability.''

Based purely on current growth and inflation trends, the RBI believes that the likelihood of further rate actions in the immediate future is relatively low. However, Dr. Subbarao said, “in an uncertain world, we need to be prepared to respond appropriately to shocks that may emanate from either global or domestic environment.''

The RBI has informed that it would release the second financial stability report in December. Going forward, the financial stability report will be published in June and December every year. It has also informed that the central bank is in the preparation of a discussion paper, which will delineate the pros and cons of deregulating the savings bank deposits interest rate. It has also decided to permit settlement of repo in corporate bonds on a T+0 basis in addition to the existing T+1 and T+2 basis.

RRB branches

The RBI decided to allow regional rural banks (RRBs) to open branches in Tier 3 to Tier 6 centres as identified in the Census 2001(with population up to 49,999), subject to fulfilling certain conditions. It has decided to open sub-offices of the RBI in the remaining six States of the Northeast, namely, Arunachal Pradesh, Nagaland, Manipur, Mizoram, Tripura and Meghalaya, in a phased manner.

Initiating several measures to strengthen the role of urban co-operation banks (UCBs), the RBI has taken the following decisions: extending area of their operations; liberalising branch licensing policy for well managed and financially sound UCBs; allowing well managed and financially sound UCBs to engage business correspondents (BCs)/business facilitators (BFs); allowing licensed UCBs the facility of INFINET membership, current and SGL accounts with the RBI; and allowing RTGS membership to well managed and financially sound UCBs having a minimum net worth of Rs.25 crore. The RBI stipulated prudential limits to regulate the investments of banks in companies engaged in forms of business other than financial services. Banks will be required to review their investments in such companies and be compliant with the guidelines as per the roadmap to be laid down.

The RBI has also decided to issue final guidelines on compensation practices by banks by end-December 2010 and to put the draft guidelines on licensing of new banks in public domain by end-January 2011 for public comments.

The RBI has increased the threshold limit for real time gross settlement system (RTGS) transactions from the present limit of Rs.1 lakh to Rs.2 lakh.

More In: Economy | Business