RBI raises key rates, but banks may hold on

Inflation-wary central bank increases repo, reverse repo rates, raises GDP forecast to 8.5%

The Reserve Bank of India (RBI) today raised key rates for a fourth time this year in the face of inflation, which has stayed stubbornly above 10 per cent for the past five months. Banks, however, are not expected to increase lending rates immediately.

In its first quarterly monetary policy review for 2010-11, the central bank lifted the repo rate by 25 basis points (bps) to 5.75 per cent, in line with expectations, and also raised the reverse repo rate by 50 bps to 4.50 per cent. The former is the rate at which RBI lends to banks and the latter at which it borrows, to absorb cash from the system. The central bank, however, left the Cash Reserve Ratio (CRR) unchanged.

In his press conference in the afternoon, RBI Governor D Subbarao said he expected both the lending and deposit rates to go up. “We expect credit to be dearer as demand picks up,” he said.

Bankers said a lending rate rise, though a near-certainty, may still take some time. State Bank of India Chairman O P Bhatt said, “By and large, lending rates will not go up in the second quarter of the current financial year.”

ICICI Bank Managing Director and Chief Executive Officer Chanda Kochhar said: “You would not see any movement but it will happen over a period of time.”

Bankers, however, said they were concerned about slow growth in deposits and may be prompted to increase deposit rates in the near future.

Inflation focus
RBI today cautioned that inflation, which is getting more generalised on capacity constraints and improving pricing power, may rise further. The bank raised its inflation forecast for March-end to 6 per cent from 5.5 per cent earlier. RBI said its policy stance has to shift to containing inflation and anchoring inflationary expectations.

Deputy Governor Subir Gokarn said the inflation rate will remain in “high single digits” for some more time.

RBI today also raised its forecast for economic growth to 8.5 per cent for the year to March 2011, compared with its earlier forecast of 8 per cent, with an upward bias, made in April.

Non-food items contributed 70 per cent to the wholesale price index inflation in June compared with nil in November, indicating that food was no longer the dominant factor for speeding the rate, RBI said. The recent increase in prices of fuel products, iron ore and electricity will push inflation up in the short term, it said. Still, there are other factors, including a normal monsoon that will increase food output and dampen food-price inflation and subdued global commodity and energy prices, that could help keep inflation under check.

By raising the reverse repo rate by higher than the usual 50 bps, the central bank is narrowing the corridor for short-term rates and reducing volatility. RBI said it aims to keep liquidity in balance and wants to prevent any excess liquidity from diluting the effectiveness of policy rate actions.

It also plans to increase the frequency of its monetary policy reviews from one in each quarter to another four in between. The next review is scheduled for September.

RBI, which had cut repo rates by about 450 bps between October 2008 and April 2009 from 9 per cent as part of the government’s stimulus to help the economy overcome impact of global financial crisis, began raising rates and tightening cash availability in the banking system this year. In January and April, it had raised CRR, while increasing the repo rate thrice, by 25 bps each in March, April and on July 2. Yet, there has been no rise in bank lending rates, though deposit rates gained as much as 100 bps between April and July, it said.

“Despite the increase in policy rates by 75 basis points cumulatively, real policy rates are not consistent with the strong growth that the economy is now witnessing,’’ the bank said.

Global worry
Subbarao said: “If the global recovery falters, the risk of which has increased since the April 2010 policy announcement, the performance of emerging market economies is likely to be adversely affected.” While India’s trade linkages with the advanced economies are appreciably smaller than those of other emerging economies, a widespread slowdown in global trade will have an impact on manufacturing and service sectors, he added.

HDFC Bank Chief Economist Abheek Barua said RBI expects frequent episodes of liquidity tightness ahead, which means that on an average, the repo rate will remain the operative policy rate. This implies another 150 bps of effective tightening entailed in the shift in the operative policy rate from the reverse repo to the repo rate over the past two months.

The country’s benchmark equity index, the Sensex, gained 57.56 points, or 0.3 per cent, to 18,077.61 today. Analysts said the market feels RBI is confident about the robust pace of economic growth. The rupee rose the most in more than five weeks, as the higher interest rates are attracting investors to local assets.

But industry isn’t happy. The Federation of Indian Chambers of Commerce and Industry said it fears the RBI actions will lead to a rise in lending rates. About 40 per cent of the respondents to Ficci’s business confidence survey mentioned high borrowing cost as an impediment to business performance, it said.

Seshagiri Rao, joint managing director at JSW Steel, said the cost of borrowing will go up. “Already, we are seeing tightness in the credit market. So, hiking interest rates at this stage may further tighten the money available in the market. Keeping into account the growth we need to achieve this year, I don’t think further interest rate hikes are warranted.”