<b>Credit Policy Review:</b> 25 bps hike in repo rates

The Reserve Bank of India (RBI) today hiked reverse repo and repo rates by 25 basis points to 6% and 7%, respectively.

The action formed part of its first quarter review of Monetary Policy 2006-07 today. The bond markets were largely expecting a 25 basis point hike in reverse repo rate.

The central left the cash reserve ratio (CRR) and the Bank Rate unchanged at 5% and 6%, respectively.

Reserve Bank Governor Y V Reddy cautioned against emerging risks such as the incomplete catch up of domestic petroleum and oil product prices with the possible permanent component of itnernational prices.

He also suggested the need to remain on guard as the growth in non-food bank credit and monetary aggregates were higher than projections and contrasting liquidity conditions in the government securities market vis-a-vis money markets.

Reddy pointed out that there were several positive factors in domestic developments during 2006-07 so far, inter alia: reasonably robust corporate performance, pick-up in investment activity, strong demand for bank credit, growth in new order books, increase in capacity utilization, ample liquidity, stabilisation of inflation since mid-June and strong export growth.

According to him, while prospects for growth in the world economy in 2006 were considered bright in the near-term as reflected in indicators of business confidence and unemployment in major economies, there were several downside risks to the economic outlook internationally as well.

They include, according to him, large fiscal deficits, low household savings and low investment in some large economies; unprecedented and growing current account imbalances; narrowing or closing in of output gaps in many economies; record highs in oil prices accompanied by uncertainties about their future evolution; the outlook for inflation firming up; the hardening of international interest rates along with the direction of movement in setting monetary policy; and re-pricing of risks by financial markets, in particular, in emerging market economies.

Reddy said the central bank will continue to ensure that appropriate liquidity was maintained in the system and that "legitimate requirements of credit are met, particularly for productive purposes, consistent with the objective of price and financial stability."

He said GDP growth forecast had been retained in the range of 7.5 to 8% during 2006-07 as projected in the annual policy statement, barring domestic or external shocks.

Reddy said while domestic developments would continue to dominate the economy, global factors would tend to gain more attention now than before.

He also said the Reserve Bank would continue with its policy of active demand management of liquidity through open market operations (OMO) including MSS, LAF and cash reserve ratio (CRR), and using all the policy instruments at its disposal flexibly, as and when the situation warrants.

Reddy said the overall stance of the monetary policy would be to:

1. Ensure a monetary and interest rate environment that enables continuation of the growth momentum while emphasising price stability with a view to anchoring inflation expectations.

2. To reinforce the focus on credit quality and financial market conditions to support export and investment demand in the economy for maintaining macroeconomic and, in particular, financial stability.

3. To consider measures as appropriate to the evolving global and domestic circumstances impinging on inflation expectations and the growth momentum.

The mid-term review of the annual policy statement will be undertaken on October 31, 2006 instead of October 17, 2006 and the third quarter review on January 30, 2007 instead of January 23, 2007 as indicated in the annual policy statement of April 2006.