Reserve Bank of India Governor YV Reddy brought the central bank “ahead of the curve” again, just weeks ahead of demitting office, with an “extreme” interest rate hike so as to enable his successor to deal with only incremental measures going forward.
Surpassing expectations on the quantum of action, Reddy raised the repo rate by 50 basis points to 9 per cent and banks’ cash reserve ratio by 25 bps to 9 per cent, besides scaling down the projection on gross domestic product growth and raising the target on inflation.
The market, which was mostly expecting a 25-bps increase in repo rate and no CRR hike today, was surprised by the intensity of the measure, but felt it could be the last of “extreme” measures.
| RATE CARD Central banks across Asia have raised key policy rates to tackle inflation, which is now a global problem, even as worries of an economic slowdown loom large. A quick glance at the Indian benchmark rates vis-a-vis those across the continent | ||||
| Key interest rates for majorAsian countries | ||||
| Country | Key rates | Rate (%) | Date of change | |
| Previous | Current | |||
| India | Repo | 8.50 | 9.00 | 29-Jul-08 |
| CRR | 8.75 | 9.00 | 30-Aug-08 | |
| China | 1-year yuan lending | 7.29 | 7.47 | 20-Dec-07 |
| 1-year yuan deposit | 3.87 | 4.14 | 20-Dec-07 | |
| Hong Kong | Discount window | 3.75 | 3.50 | 2-May-08 |
| South Korea | Base rate | 4.75 | 5.00 | 9-Aug-07 |
| Taiwan | Discount | 3.50 | 3.63 | 26-Jun-08 |
| Indonesia | Target for 1-month | 8.50 | 8.75 | 3-Jul-08 |
| Thailand | 1-day repurchase | 3.25 | 3.50 | 16-Jul-08 |
| Philippines | Overnight borrowing | 5.25 | 5.75 | 17-Jul-08 |
| Overnight lending | 7.25 | 7.75 | 17-Jul-08 | |
| Vietnam | Discount | 11.00 | 13.00 | 10-Jun-08 |
| Rediscount | 13.00 | 15.00 | 10-Jun-08 | |
| Base rate | 12.00 | 14.00 | 10-Jun-08 | |
| Source: Reuters | ||||
“There could be more interest rate and CRR hikes, but those could be of a smaller magnitude,” an economist said.
In a matter of seven weeks, the RBI has hiked the repo rate by 125 bps. It has raised CRR by 150 bps since April.
The intensity of RBI’s measures increased after inflation soared close to 12 per cent and the government emphasised that the central bank was the “first line of defence” against inflation.
“At this point of time, RBI is in line with the curve,” said Abheek Barua, chief economist at HDFC Bank, the country’s second largest private sector bank. “In fact it has gone a little ahead of the curve. It has gone beyond market expectations in terms of measures. So, they have sort of caught up with the curve now.” Most economists said the central bank had fallen “behind the curve” after inflation began to rise since February and zoomed to a 13-year high.
The headline inflation was 11.89 per cent for the week to July 12 and is expected to stay firm in the coming months.
Reddy acknowledged that it is realistic to expect inflation to climb down to 7 per cent by March and not to 5.5 per cent as targeted earlier.
Yield curve
It is ironic that RBI had fallen behind the curve. The central bank was once believed to be way ahead of the curve because it kept raising interest rates citing an inflationary spectre, when not many others saw it. It was well known in banking circles that RBI was raising interest rates at a time when the government wanted them to be soft.
Finance Minister P Chidambaram had, in fact, said the RBI was ahead of the curve after the central bank raised repo rate by 25 bps on Jan 24, 2006. He had then hoped the central bank would reverse the interest rate hike.
Twenty-nine months, six interest rates and seven CRR hikes later, the RBI has found itself behind the curve this year.
The sharp hike in interest rates and CRR since then have led economists to believe the central bank will only take smaller measures now.
