The cost of borrowing will increase sharply

The Reserve Bank of India (RBI) on Thursday hiked the short-term indicative policy rate (the repo rate) by 25 basis points to 7.5 per cent from 7.25 per cent with immediate effect.

Consequently, the reverse repo rate will stand automatically adjusted to 6.5 per cent and the marginal standing facility (MSF) rate to 8.5 per cent with immediate effect.

This would “contain inflation and anchor inflationary expectations by reining in demand side pressures and mitigate the risk to growth from potentially adverse global developments,” the RBI said in its first mid-quarter review of Monetary Policy 2011-12.

“Inflation persists at uncomfortable levels,” said the RBI. Moreover, the headline numbers understate the pressures because fuel prices have yet to reflect global crude oil prices. On the growth front, even as signs of moderation are visible in some sectors, the RBI said, “broad indicators of activity — 2010-11 fourth quarter profit growth and margins and credit growth do not suggest a sharp or broad-based deceleration.”

The repo rate is the rate at which banks borrow funds from the RBI and the reverse repo rate is the rate at which banks park their funds with the central bank. This means that the cost of borrowing will increase sharply and the EMIs for home, auto and personal loans are set to go up further.

Monetary transmission has been quite strong with 45 scheduled commercial banks raising their base rates by 25-100 basis points after the May 3 Policy Statement. Cumulatively, 47 banks raised their base rates by 150-300 basis points during July 2010-May 2011. The higher cost of credit is restraining credit growth, but it still remains fairly high, suggesting that economic activity is holding course.

Going forward, notwithstanding signs of moderation in commodity prices and some deceleration in growth, domestic inflation risks remain high, the RBI said, adding, against this backdrop, the Monetary Policy stance remains firmly anti-inflationary, recognising that, in the current circumstances, “some short-run deceleration in growth may be unavoidable in bringing inflation under control.”

GDP growth decelerated to 7.8 per cent in the fourth quarter of 2010-11 from 8.3 per cent in the previous quarter and 9.4 per cent in the corresponding quarter a year ago. GDP growth in 2010-11 was 8.5 per cent.

The main drivers of WPI inflation in the first two months of the current fiscal (April-May 2011) were non-food primary articles, fuel group and non-food manufactured products. The consumer price inflation for industrial workers (CPI - IW) rose from 8.8 per cent in March to 9.4 per cent in April.

Non-food manufactured products inflation was 8.5 per cent in March. Provisional data indicate that it increased from 6.3 per cent in April to 7.3 per cent in May, numbers much above its medium-term trend of 4 per cent.

Year-on-year non-food credit growth moderated from 21.3 per cent in March to 20.6 per cent in early June, but remained above the indicative projection of 19 per cent. The year-on-year deposit growth increased to 18.2 per cent in early June from 17 per cent in March. Consequently, the incremental non-food credit-deposit ratio moderated to 80.5 per cent (year-on-year) in early June from 95.3 per cent in March. The year-on-year increase in money supply (M3) was at 17.3 per cent in early June as compared with 16 per cent in March. “Domestic fuel prices do not yet reflect the current trends of global prices. Although global commodity prices moderated in recent weeks, it is too early to downgrade this as a risk factor. Monetary transmission has strengthened. The impact of the RBI's recent Monetary Policy actions is still unfolding,” the RBI added.