Surprises market with 25-basis-point rise; banks not to increase rates immediately.
The Reserve Bank of India (RBI) today surprised banks and money market players by raising key policy rates 25 basis points. The move, aimed at taming inflation and anchoring inflationary expectations, marks a reversal in the easy monetary policy regime amid signs of strong economic revival.
In a statement, the central bank said the repo rate, or the rate at which banks borrow from RBI, is being increased 25 basis points to 5 per cent.
Similarly, the reverse repo rate, or the rate at which surplus cash is parked with the central bank, was also increased to 3.5 per cent from 3.25 per cent earlier.
| RAISING THE STAKES | |||
| Repo | Reverse repo | ||
| Effective date | Rate (%) | Effective date | Rate (%) |
| Jun 24 ‘08 | 8.50 | Jun 8 ‘06 | 5.75 |
| Jul 29 ‘08 | 9.00 | Jul 25 ‘06 | 6.00 |
| Oct 20 ‘08 | 8.00 | Dec 8 ‘08 | 5.00 |
| Nov 3 ‘08 | 7.50 | Jan 2 ‘09 | 4.00 |
| Dec 8 ‘08 | 6.50 | Mar 4 ‘09 | 3.50 |
| Jan 2 ‘09 | 5.50 | Apr 21 ‘09 | 3.25 |
| Mar 4 ‘09 | 5.00 | Mar 19 ‘10 | 3.50 |
| Apr 21 ‘09 | 4.75 | ||
| Mar 19 ‘10 | 5.00 | ||
The increase in rates was not expected till April 20, when RBI’s annual policy was due.
This is the second action since January when RBI announced a 75-basis point rise in the cash reserve ratio (CRR) to 5.75 per cent.
But, unlike CRR, which is used to manage liquidity in the system, an increase in the repo and reserve repo rates is aimed at signalling an increase in interest rates.
RBI joined central banks in Australia and Malaysia, which raised rates this month, while Norway and Israel did so at the end of last year. The US Federal Reserve and the European Central Bank are among those waiting for evidence of a more concrete recovery before they unwind record low borrowing costs.
In India, banks are expected to wait till next month before taking a decision on raising rates, having raised lending and deposit rates following the CRR increase.
“There may not be an immediate rise in lending rates, as just 10 days are left for the close of this financial year. Banks will wait for further signals from the central bank before they decide to raise lending rates,” said R S Reddy, chairman and managing director, Andhra Bank.
“There has already been some pre-emptive action by banks on deposit rates and the latest rate rise will not warrant any significant strategy changes for the asset liability committee. It will normalise market interest rates,” added Yes Bank Managing Director and CEO Rana Kapoor.
Besides, as ICICI Bank Managing Director and CEO Chanda Kochhar pointed out, that there was ample liquidity in the market. “We need to wait and see the credit offtake and systemic liquidity to assess the medium term impact on lending and borrowing rates,” she said.
“It is signal from RBI that money will be costlier,” said State Bank of India’s Chief Financial Officer S S Ranjan.
He, however, added that the bank will take a call on its special housing finance scheme under which interest rates are fixed for the first three years. SBI is the only bank to be offering such a scheme at present; others have pulled out.
The RBI move is also unlikely to impact corporate borrowing plans. “It will not have a major impact on corporate borrowings. As interest rates have just started moving up, there will be a sharper increase in corporate borrowings as companies will rush to banks to meet their credit requirements in the next three to five months,” Prabal Banerji, Group CFO, Hinduja said.
Today’s move by RBI is the first increase in policy rates since July 2008 when the repo rate was increased 50 basis points. The reverse repo was last raised in July 2006, when RBI raised the rate 25 basis points.
Since October, 2008, RBI started the process to reduce interest rates and lowered the CRR to inject liquidity in the system to spur economic activity in the wake of the global downturn.
RBI’s action today is a signal that it will act to curb inflationary expectation, if needed, in small measures so that growth is not hurt, said Chief Economic Advisor Kaushik Basu.
“It (RBI action) is not surprising as manufacturing inflation has started rising... I expect RBI to raise the repo rate and reverse repo rate by another 25 basis points each,” HDFC Bank chief economist Abheek Barua said.
Citigroup economists Rohini Malkani and Anushka Shah had projected a 125-basis point increase in policy rates this year.
Today’s move comes against the backdrop of rising inflation which touched 9.89 per cent in February and RBI for the first time said that wholesale price index-based inflation may cross double digits in March 2010. In January, it had estimated that inflation may reach 8.5 per cent by March-end.
“Notwithstanding some moderation in recent weeks, food prices remain at elevated levels. In fact, consumer price inflation, as measured by various consumer price indices, has accentuated further. The acceleration in the prices of non-food manufactured goods and fuel items in recent months has been of particular concern,” it said.
RBI drew comfort from pick-up in the economic recovery and pointed to robust industrial growth, exports turning positive and a sustained increase in bank credit and resource mobilisation by the commercial sector from non-bank sources. At the same time, it said: “The recent industrial production data suggest revival of private demand, which could potentially add to inflationary pressures.”
Though RBI Deputy Governor Subir Gokarn had initially suggested that the central bank would prefer to wait till April, when the annual policy is due, to raise rates, an indication of a change in stance came yesterday, when K C Chakrabarty, another deputy governor, said RBI had kept all options open.
“Our assessment is that at this juncture further policy action is warranted. Given the lags in monetary policy, it is better to respond in a timely manner, even if it is outside the scheduled policy reviews, than take stronger measures at a later stage when inflationary expectations have accentuated,” RBI explained in a statement this evening.
It said this step will anchor inflationary expectations and contain inflation going forward. “As liquidity in the banking system will remain adequate, credit expansion for sustaining the recovery will not be affected… The Reserve Bank will continue to monitor macroeconomic conditions, particularly the price situation, and take further action as warranted,” the statement added.
“The rate hike action has come as a surprise. The market did not expect RBI to act before the annual policy. The yield on government bonds may rise by up to 15 basis points on Monday. The hardening of yields is here to stay,” said B Prasanna, MD & CEO ICICI Securities Primary Dealership.
Bond dealers said yield on government securities, which eased to 7.82 per cent today, from a 17-month high of 8.02 per cent last week, could harden in the days ahead.
The RBI announcement came after market hours.
The stock markets are also expected to factor in the impact of the rate hike when they open for trading on Monday. Following the announcement, SGX Nifty futures, which trade on the Singapore OTC exchange, fell by 1 per cent. SGX Nifty March futures were trading around 5,202 compared to official close of 5,268 points.
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