In an aggressive move to tame inflation and inflationary pressure, the Reserve Bank of India on Thursday raised the indicative short-term lending (repo) rate by 25 basis points to 6 per cent from 5.75 per cent and the borrowing (reverse repo) rate by 50 basis points to 5 per cent from 4.5 per cent with immediate effect.
The repo rate is the rate at which the RBI lends money to banks and the reverse repo rate is the rate at which banks park their funds with the central bank.
This is the first mid-quarter policy review since the RBI said it would increase the frequency of its policy reviews to eight from four in a year.
These measures, according to the central bank, would “contain inflation and anchor inflationary expectations without disrupting growth and reduce the volatility in overnight call money rates and strengthen the monetary transmission mechanism.” The RBI said in its Mid-quarter Monetary Policy Review.
While raising the deposit rate aggressively the RBI said “banks have seen a deceleration of deposit growth, as savers look for higher returns elsewhere. If bank credit is not to become a constraint to growth, real rates need to move in the direction of encouraging bank deposits.”
On the inflation rate, the RBI said “inflation rates have reached a plateau, but are likely to remain at unacceptably high levels for some months.”
While prices of food articles — rose by over 14 per cent in August — are still contributing to the pressure, about two-thirds of the August inflation can be attributed to items other than food articles and products. However, the RBI said the direction of the inflation rate movement is consistent with its projection made in the July review, “though the magnitude could be slightly different.”
Another aspect of the concern with inflation is its implications for real interest rates, the RBI said. The policy actions taken over the past three quarters have been partly motivated by the need to end the prevalence of negative real interest rates. “This was sought to be accomplished by a combination of increasing policy rates in a non-disruptive manner and declining inflation rates,” the RBI said, adding, the transmission from policy rates to market rates has strengthened, with 40 banks raising their deposit rates and 26 raising their lending rates. “These circumstances are expected to prevail, maintaining the repo rate as the effective policy rate and sustaining the strength of the transmission mechanism,” the RBI said.
With reference to government finances, the RBI said that higher than expected realisations on 3G and broadband wireless access (BWA) auctions combined with buoyant tax revenues have virtually eliminated the risk of the fiscal deficit overshooting the targeted 5.5 per cent, even after the supplementary demand for grants is taken into account. “This will help stabilise market expectations of liquidity and interest rate movements.”
On the external front, the continuing sluggishness of the global economy constrains export growth while the strong domestic recovery has increased demand for imports.
As a result, the trade deficit, and with it the current account deficit, are widening, the RBI said
Policy stance on expected lines: SBI
While reacting to policy measures, State Bank of India Chairman O. P. Bhatt said: “short-term rates are already up and the market-led tightening has now got reflected in policy, commensurate with the economy's fundamentals. As the economy has picked up and inflation is also trending up, the shift in the monetary policy stance from being accommodative is on expected lines.”
With stronger domestic demand along with supply side constraints feeding into elevated inflation expectations and headline inflation well beyond the RBI's indicative target, the central bank has continued to focus on inflation management and move towards normalising policy rates by hiking the repo and reverse repo rates 25 in the mid-quarter review, Mr. Bhatt felt.
