Resolving to rein in rising inflation the Reserve Bank of India (RBI) on Tuesday raised the short-term indicative lending rate (repo) by 25 basis points from 5.5 per cent to 5.75 per cent and the borrowing rate (reverse repo) by 50 basis points from 4 per cent to 4.50 per cent with immediate effect.
“The dominant concern that has shaped the monetary policy stance in this review is high inflation,” said D. Subbarao Governor, RBI, while addressing a press conference here after meeting chief executives of major banks
Even as food price inflation and, more generally, consumer price inflation, has shown some moderation, they are still in double digits. Non-food inflation has risen, and demand side pressures are clearly evident. “With growth taking firm hold, the balance of policy stance has to shift decisively to containing inflation and anchoring inflationary expectations,” he added.
Dr. Subbarao said, this asymmetric rise in rates narrows the Liquidity Adjustment Facility (LAF) corridor from 150 basis points to 125 basis points.
He said that the macroeconomic developments in India were contrarian to the global trend. “We have recovered faster, but our inflation rate has also been higher.”
Better farm sector prospects should lead to a pick-up in rural demand, said Dr. Subbarao This should give further momentum to the performance of the industrial sector which has been growing firmly.
However, he warned that while domestic drivers of growth were robust, any slowdown in the global recovery would affect all emerging market economies (EMEs), including India.
Taking into account the emerging domestic and external scenario, the baseline projection for wholesale price index (WPI) inflation for March 2011 has been raised to 6 per cent from the April policy projection of 5.5 per cent.
Going forward, according to the RBI Governor, the outlook on inflation will be shaped by: the monsoon performance for the remaining period; movements in global energy and commodity prices, which have been showing distinct signs of softening over the past few weeks; and potential build-up in demand-side pressures with the strengthening of domestic growth drivers.
Dr. Subbarao said that “today's policy action in particular has been informed by three major considerations: domestic economic recovery is firmly in place and is strengthening; there is a need to contain the demand-side inflationary pressures which are clearly evident; and despite the increase in the policy rates by 75 basis points cumulatively, it is imperative that we continue in the direction of normalising our policy instruments to a level consistent with the evolving growth and inflation scenario, while taking care not to disrupt the recovery.
He said that the monetary policy actions were expected to moderate inflation by reining in demand pressures and inflationary expectations; maintain financial conditions conducive to sustaining growth; generate liquidity conditions consistent with more effective transmission of policy actions; and restrict the volatility of short-term rates to a narrower corridor.
Working group
The RBI Governor also said that the central bank would set up a working group to review the current operating procedure of monetary policy of the Reserve Bank, including the LAF.
Dr. Subbarao said in a rapidly evolving macroeconomic situation “We need to combine the rigour and comprehensiveness of the quarterly process with the responsiveness and flexibility of more frequent reviews.” Accordingly, the Reserve Bank will now undertake mid-quarter reviews roughly at the interval of about one and half months after each quarterly review.”
The RBI Governor, after his discussion with bank chiefs, said that banks indicated that the liquidity situation might remain tight for some more time as deposit growth had lagged behind credit growth. They felt that a narrower LAF corridor would restrict short-term interest rate volatility and improve monetary transmission.
The Reserve Bank emphasised that the pace of credit expansion to MSMEs should be sustained and banks should sensitise the frontline managers the importance of lending to MSMEs.
