The Reserve Bank of India (RBI) today raised its key policy rates by a quarter percentage point each to combat inflation, but signalled a pause by saying that “the likelihood of further rate actions in the immediate future is relatively low”.
In its monetary policy review, the central bank raised the repo rate to 6.25 per cent and reverse repo to 5.25 per cent, as inflation is still higher than its comfort zone.
This is the sixth increase in repo rate by RBI since the beginning of the year. It has raised the repo rate by 150 basis points since the first hike in March, as part of a process of reversing the 425-basis point cuts between October 2008 and April 2009.
RBI Governor D Subbarao told reporters after presenting the monetary policy review that the bank would refrain from action for at “least three months”, unless there is some unforeseen development. “We have reached the normal levels on interest rates. Further action will be driven by the growth and inflation situation and implications of external developments,” he added.
In the money markets, 12-year bonds gained the most in more than two months. Yields on most-traded debt due 2022 fell to the lowest level since September. Bonds also advanced as the central bank said it would offer to buy as much as Rs 12,000 crore in government debt at an auction on November 4 to help ease a cash crunch at banks.
| A MULTI-PRONGED APPROACH |
| * Repo and reverse repo rates up by 25 basis points each |
| * Cash reserve ratio and bank rate are left untouched at 6% |
| * Housing loans capped at 80% of the value of a property |
| * Risk weight for home loans above Rs 75 lakh hiked 25 bps |
| * Provisioning for teaser rates on housing loans raised to 2% |
| * Financial conglomerates’ capital adequacy norm tightened |
The equity market, however, was somewhat unmoved by the monetary policy announcement, except for real estate stocks, which fell sharply after the sector came in for special treatment from the central bank. Benchmark indices ended almost flat, as observers said the market had factored in the increase in policy rates, and is more focused on the US Federal Reserve’s policy meeting later today and tomorrow, which may herald a new round of monetary easing to bolster the world’s largest economy.
Bankers said there may not be any immediate rise in their cost of funds to warrant an increase in interest rates, but there is an “upward bias”. State Bank of India Chairman O P Bhatt said any increase in rates would depend on the demand for credit going forward, but “as of now” banks are in a position to absorb the increase in rates and higher provisioning norms in home loans.
HDFC Bank Managing Director Aditya Puri said, “There is no need for a kneejerk reaction on interest rates.” Most agree that an interest rate hike, if any, will take place only in the January-March quarter.
While maintaining its estimates on gross domestic product (GDP) and inflation at 8.5 per cent and 5.5 per cent, respectively, for FY11, RBI has highlighted that the key risk to growth would emanate from the global front, given the impact of trade on both manufacturing and services. On inflation, in addition to sticky food prices, RBI has said that inflationary pressures may accentuate due to a quantitative easing-related rise in global commodity prices and growing domestic capacity-utilisation levels. Moreover, it has voiced concern on rising asset prices in the real estate and precious metals space.
While stating that a liquidity deficit is consistent with an anti-inflationary stance, RBI has admitted that “excessive deficiency can be disruptive and needs to be contained within a reasonable limit”. Citigroup India Economist Rohini Malkani said this does hint that RBI is open to taking further measures to ease liquidity.
Rs Rs Food price inflation has remained persistently elevated for over a year now, reflecting in part the structural demand-supply mismatches in several commodities – besides protein sources, oilseeds, and vegetables also show this pattern,’’ RBI said.
RBI will continue to maintain some controls on debt-creating fund flows, even as it prefers fund flows into equity capital, Subbarao said, adding that the monetary policy stance has been calibrated by the widening current account deficit in the country's balance of payments. If the trend of the first quarter of 2010-11 persists, the current account deficit as a percentage of GDP for the full year will be significantly higher than last year, he pointed out.
"It is generally perceived that a current account deficit above 3 per cent of GDP is difficult to sustain over the medium term," he said. However, considering the need for investment capital and the tight liquidity conditions within the economy, the governor said, monetary policy should aim at "actively managing liquidity to ensure that it remains broadly in balance, with neither a surplus diluting monetary transmission nor a deficit choking off fund flows".
The central bank promised to provide sufficient liquidity to ensure credit flows to different sectors. In a major shift in its stance from the previous announcement, when it projected liquidity to remain in deficit for better inflation control, RBI said it would ensure liquidity is “broadly in balance”. It retained its 20 percent credit growth projection for the year to March.
The central bank proposed to impose prudential limits to regulate investment by banks in businesses other than financial services. It also plans to increase supervision of financial conglomerates and implement capital adequacy for such conglomerates and changes in their regulatory norms, including those for intra-group transactions and exposures.
As part of the process to give licences to new banks in the private sector, RBI said it will issue draft guidelines by January end. A discussion paper on whether foreign banks should be present in India as a wholly-owned subsidiary or branch is in the final stages.
RBI’s decision to hike rates, however, came in for some sharp criticism from industry chambers such as Ficci. Stressing that this move could seriously impact consumption demand, Amit Mitra, secretary-general of the chamber, said RBI has been “over cautious”.
