In its pursuit to contain price rise in the economy the Reserve Bank of India (RBI) on Thursday hiked the short-term indicative rates by 25 basis points.

Since last March, this is the eighth time the RBI increased the rates and this move of the central bank would increase the borrowing cost of customers.

The central bank has increased the repo rate by 25 basis points from 6.5 per cent to 6.75 per cent and the reverse repo rate by 25 basis points from 5.5 per cent to 5.75 per cent with immediate effect.

Repo rate is the rate at which banks borrow money from the central bank and reverse repo is the rate at which banks park their funds with the central bank.

In its mid-quarter monetary policy review, the RBI said that further upside risks have stemmed from high international crude prices, their impact on freely priced petroleum products, increase in administered coal prices and pick-up in non-food manufactured product prices. “The March 2011 WPI inflation is now estimated to be higher, around 8 per cent.” In its third quarter review, the Reserve Bank had projected year-on-year WPI inflation for March 2011 at 7 per cent.

“The underlying inflationary pressures have accentuated, even as risks to growth are emerging,” RBI warned. Rising global commodity prices, particularly oil, are a major contributor to both developments. As domestic fuel prices are yet to adjust fully to global prices, risks to inflation remain clearly on the upside, reinforced by the persistence of demand-side pressures as reflected in non-food manufacturing inflation.

The Union Budget for 2011-12 indicates some easing of demand pressures from the fiscal side, thus creating space for private investment, but this will materialise only if commitments to contain subsidies are adhered to. The RBI expects, however, that measures to increase agricultural productivity, particularly in items facing structural supply-demand imbalances, will contribute to easing food inflation over time,

Indicating that it would not hesitate to take further action to tame inflationary pressure, the RBI said, “based on the current and evolving growth and inflation scenario, the Reserve Bank is likely to persist with the current anti-inflationary stance.”

The RBI said that this policy action was expected to manage inflationary expectations and contain the spillover of food and commodity prices into more generalised inflation and continue to rein in demand-side inflationary pressures while minimising risks to growth.

The central bank said that after a slight moderation in January headline WPI inflation reversed in February 2011 accompanied by a sharp increase in non-food manufactured products inflation. The prices of protein sources such as milk and ‘eggs, meat and fish' continued to remain high reflecting structural demand-supply imbalances.

A number of measures contained in the budget for 2011-12 to improve the agricultural supply response in the medium-term will aid in redressing these imbalances. However, fuel prices remain high, reflecting the global trend, with potential for further rise. Significantly, non-food manufactured products inflation, an indicator of demand-side pressure, rose sharply from 4.8 per cent in January to 6.1 per cent in February and continues to stay well above its medium-term trend.

“The acceleration was spread across manufacturing activities, indicating that producers are able to pass on higher input prices to consumers,” the RBI added.

On credit conditions, the RBI noted that while the year-on-year non-food credit growth at 23 per cent in February remained above the indicative projection of 20 per cent, the pace of credit expansion had moderated since December 2010. “Monetary transmission is increasingly visible as banks continue to raise their lending rates.”

However, on liquidity situation it said that the overall liquidity situation was expected to move close to the comfort level of the Reserve Bank “although it is likely to come under some temporary pressure in the second-half of March due to advance tax collections.”

The RBI also said that if the current inflationary pressure persisted the current growth momentum would be derailed. GDP growth of 8.6 per cent for 2010-11 is consistent with the Reserve Bank's projection set out in the third quarter review. However, it said continuing uncertainty about energy and commodity prices might vitiate the investment climate, posing a threat to the current growth trajectory. In particular, “the weak performance of capital goods in the index of industrial production (IIP) suggests that investment momentum may be slowing down.”

Inflationary pressures in emerging market economies (EMEs) are already high as output gaps have narrowed, while headline inflation has risen noticeably in a number of advanced economies, especially in the euro area and the U.K. Consequently, an increasing number of EMEs have begun monetary tightening, while the debate on exit from the accommodative monetary stance has come to the fore in advanced economies.

It is as yet too early to assess the macroeconomic consequences of the natural disaster in Japan, it said. As normalcy is restored, expenditure on reconstruction may provide a boost to the economy. However, it added that substitution of thermal for nuclear energy in Japan might exert further pressure on petroleum prices.

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