A determined Reserve Bank of India (RBI) on Tuesday hiked the short-term indicative policy rate (repo rate) by 50 basis points from 6.75 per cent to 7.25 per cent to tame soaring inflation while increasing the savings bank rate to 4 per cent from 3.5 per cent.

The regulated savings bank rate was remaining at 3.5 per cent since April 2003. With the hike in repo rate, the rate at which banks borrow from the central bank, home auto and other loans would be costlier for customers.

“There will henceforth be only one independently varying policy rate, and that will be the repo rate. This transition to a single independently varying policy rate is expected to more accurately signal the monetary policy stance,” said RBI Governor D. Subbarao while announcing the Annual Monetary Policy.

“Higher inflation will persist, and may indeed get worse,” said Dr. Subbarao.

“Headline and core inflation have significantly overshot even the most pessimistic projections over the past few months. This raises concerns about inflation expectations becoming unhinged.........Over the long run, high inflation is inimical to sustained growth as it harms investment by creating uncertainty. Current elevated rates of inflation pose significant risks to future growth. Bringing them down, therefore, even at the cost of some growth in the short-run, should take precedence,” Dr. Subbarao added.

As per the new operating procedure, the reverse repo rate, determined with a 100 basis point spread below the repo rate, will stand adjusted at 6.25 per cent. The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, gets calibrated at 8.25 per cent. However, the Bank Rate remains unchanged at 6 per cent and the cash reserve ratio (CRR) at 6 per cent.

The RBI Governor said that high oil and other commodity prices and the impact of the Reserve Bank's anti-inflationary monetary stance would moderate growth. Based on the assumption of a normal monsoon, and crude oil prices averaging $110 a barrel over the full year 2011-12, RBI projected the real GDP growth for 2011-12, for policy purposes, at around 8 per cent as compared to an estimated growth of 8.6 per cent last year.

Keeping in view the domestic demand-supply balance, the global trend in commodity prices, and the likely demand scenario, the RBI projection for WPI inflation for March 2012 is 6 per cent with an upward bias.

“Inflation is expected to remain at an elevated level in the first-half of the year, before gradually moderating to 6 per cent by March 2012,” said Dr. Subbarao.

“High and persistent inflation undermines growth by creating uncertainty for investors, and driving up inflation expectations. An environment of price stability is a pre-condition for sustaining growth in the medium-term. Reining in inflation should therefore take precedence even if there are some short-term costs by way of lower growth”.

Further, the RBI Governor said “We will be instituting a new Marginal Standing Facility (MSF)”. Banks can borrow overnight from the MSF up to one per cent of their respective net demand and time liabilities. The rate of interest on amounts accessed from this facility will be 100 basis points above the repo rate. The MSF will come into effect from the fortnight beginning May 7. Dr. Subbarao said that it had broadly accepted the framework of regulations for Micro Finance Institutions (MFIs) recommended by the Malegam Committee. Bank loans to all MFIs, including NBFCs working as MFIs on or after April 1, 2011, will be eligible for classification as priority sector loans if, and only if, they conform to the regulations formulated by the Reserve Bank.

As recommended by the Malegam Committee, the Reserve Bank has also decided to appoint a Committee to review the priority sector lending classification.

Dr. Subbarao also said that a broad goal driving RBI's financial inclusion initiative was to provide banking access to all villages with population of over 2,000 by March 2012. There are 72,800 villages identified as falling into this category. “We are asking banks to ensure that at least 25 per cent of the new branches being opened during this year are located in Tier-5 and Tier-6 centres”.

In the area of financial markets, there are three important initiatives. The RBI will shortly issue the final guidelines on credit default swaps. Second, the period of short sale in government securities will be extended from the existing five days to a maximum of three months. Third, FIIs will be allowed to cancel and rebook up to 10 per cent of the market value of the portfolio as at the beginning of the financial year.

Moving on to regulatory measures for commercial banks, the RBI Governor highlighted two measures. First, the provisioning requirements on certain categories of non-performing advances and restructured advances will be enhanced. Second, investment by banks in liquid schemes of debt-oriented mutual funds will be subject to a prudential cap of 10 per cent of their net worth as on March 31 of the previous year.

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