The Reserve Bank of India (RBI) hiked the short-term indicative interest rates (repo and reverse repo rates) by 25 basis points to mitigate rising inflation and inflationary pressures.
It has decided to increase the repo rate, the rate at which the banks borrow funds from the central bank, by 25 basis points from 5.25 per cent to 5.50 per cent and the reverse repo rate, the rate at which banks park their funds with the central bank, by 25 basis points from 3.75 per cent to 4 per cent with immediate effect.
These monetary measures should contain inflation and anchor inflationary expectations going forward, while not hurting the recovery process. Easing liquidity and raising rates at the same time may seem apparently inconsistent.
It should be noted in this context that the liquidity easing measures have become necessary to manage what is essentially a temporary and unanticipated development. In no way should they be viewed as inconsistent with the monetary policy stance of calibrated exit, which remains focussed on containing inflation and anchoring inflationary expectations without hurting growth.
The RBI has also decided to extend liquidity management measures: Additional liquidity support to scheduled commercial banks to the extent of up to 0.5 per cent of their net demand and time liabilities (NDTL) currently set to expire on July 2, 2010 is now extended up to July 16, 2010. For any shortfall in maintenance of statutory liquidity ratio (SLR) arising out of availment of this facility, banks may seek waiver of penal interest purely as an ad hoc measure; Further, the second Liquidity Adjustment Facility (SLAF) will be conducted on a daily basis up to July 16. Explaining the rationale for extension of liquidity management measures, the RBI stated that in late May 2010, in anticipation of the liquidity pressures on account of payments for 3G spectrum and advance taxes, the Reserve Bank took certain liquidity easing measures.
Even as the liquidity situation has begun to ease, these measures are being extended since liquidity tightness may persist.
RBI stated that there have been significant macroeconomic developments since the April 2010 Monetary Policy Statement. At the global level, the recovery is strengthening. However, the outlook continues to be clouded by uncertainty in the Euro area.
On the domestic front, RBI stated that the revised growth estimates by the Central Statistical Organisation (CSO) for 2009-10 and for fourth quarter of 2009-10 suggest that the recovery is consolidating.
The manufacturing sector has recorded robust growth in recent months, aided among others, by expanding exports.
The strong underlying growth momentum is also evidenced by the sharp upturn in the capital goods sector, acceleration in credit growth and the widening current account deficit.
The developments on the inflation front, however, raise several concerns, it said. Overall WPI inflation increased to 10.2 per cent in May, up from 9.6 per cent in April. Food price inflation and consumer price inflation remain at elevated levels. There has been some moderation in food price inflation, but the price index of food articles continues to increase. “More importantly, the prices of non-food manufactured goods and fuel items have accelerated in recent months”.
“Although entirely justified in terms of long-term fiscal and energy conservation objectives, the recent increase in fuel prices will have an immediate impact of around one percentage point on WPI inflation, with second round effects being felt in the months ahead.
“This mid-cycle policy action has been warranted by the evolving macroeconomic situation. Even as data for real GDP growth and WPI inflation became available by mid-June 2010, it was considered inadvisable to raise the policy rates as the financial system was dealing with liquidity pressures triggered by sudden build-up in government cash balances occasioned by the larger than anticipated level of 3G spectrum and broadband wireless access auction realisations.”
However, the RBI stated that the monsoon situation so far had been decidedly better than during last year holding prospects for good agriculture growth.
