RBI remains hawkish, raises repo rate by 25 bps to 7.75%

The Indian central bank continued its hawkish stance on fighting inflation with 25 basis points hike in repo rate, or the rate at which commercial banks borrow from the central bank, to 7.75 per cent in its monetary policy review on Tuesday.

This is the second such move under the new chief Raghuram Rajan in almost five weeks, aimed at controlling inflation in the country which is raring to go up again. In his first mid-quarter policy review last month Rajan had surprised the markets with a rate hike which spooked investors.

However, the latest rate hike was widely anticipated, which buoyed the benchmark market indices after the policy monetary announcement, despite it being seen as negative development for servicing interest cost for corporate borrowers. S&P BSE Sensex, the 30-stock benchmark index, rose 1.7 per cent on Tuesday.

The RBI also reduced the marginal standing facility (MSF) rate by 25 basis points from 9 per cent to 8.75 per cent while keeping cash reserve ratio (CRR) unchanged at 4 per cent of net demand and time liability (NDTL).

MSF rate is the rate at which banks borrow funds overnight from RBI against approved government securities and a cut in rate eases liquidity in the system. RBI chief has wielded the axe to cut it sharply from 10.25 per cent when he took over to 8.75 per cent now through three rounds of cuts.

Consequently, the reverse repo rate stands adjusted to 6.75 per cent and the bank rate stands reduced to 8.75 per cent. With these changes, the MSF rate and the bank rate are recalibrated to 100 basis points above the repo rate.

“The policy stance and measures in this review are intended to curb mounting inflationary pressures and manage inflation expectations in a situation of weak growth. These will help strengthen the environment for growth by fostering macroeconomic and financial stability,” RBI said on Tuesday.

It added that the recent upturn of inflation and with inflation expectations remaining elevated anticipating the pass-through of exchange rate depreciation and ongoing adjustment in administered fuel prices, it is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth.

“With the reduction of the MSF rate and the increase in the repo rate in this review, the process of re-aligning the interest rate corridor to normal monetary policy operations is now complete,” according to RBI.

From September, as steps to contain the current account deficit (CAD) started taking effect in an improving external environment, volatility in the foreign exchange market ebbed and it became possible to unwind the exceptional liquidity tightening measures. Keeping in view the need to infuse liquidity into the system to normalise liquidity conditions, term repos will now be conducted for a total notified amount equivalent to 0.5 per cent of NDTL of the banking system. In addition, the MSF rate will be reduced by 25 basis points.

The central bank said, the outlook for global growth has improved modestly since September, with fiscal concerns abating in the US and lead indicators of activity firming up in the Euro area and the UK. Moreover, in emerging economies, the prospect of delay in the taper of the Federal Reserve’s bond purchases has brought calm to financial markets, and capital flows have resumed.

But it cautioned that headwinds to growth from domestic constraints continue to pose downside risks, and vulnerabilities to sudden shifts in the external environment remain.

It pointed out that industrial activity has weakened but strengthening export growth and signs of revival in some services, along with the expected pick-up in agriculture, could support an increase in growth in the second half of 2013-14 relative to the first half, raising real GDP growth from 4.4 per cent in Q1 to a central estimate of 5 per cent for the year.

Referring to rising prices, it observed that the pass-through of rupee depreciation into prices of manufactured products is acting, along with elevated food and fuel inflation, to offset possible disinflationary effects of low growth. While food price pressures may ease with the arrival of the kharif harvest and the usual seasonal moderation, overall WPI inflation is expected to remain higher than the current levels through most of the remaining part of the year, warranting an appropriate policy response.

Notwithstanding the expected edging down of food inflation, retail inflation is likely to remain around or even above 9 per cent in the months ahead.

The central bank said that to provide market participants with additional access to primary liquidity, as well as greater flexibility in managing reserve requirements, term repos of seven-day and 14-day tenor have been introduced to provide liquidity equivalent to 0.25 per cent of NDTL.

It added that policy interventions have bridged the external financing gap but normalcy will be restored to the exchange market only when the demand for dollars from public sector oil marketing companies is fully returned to the market.

The next mid-quarter review of monetary policy is scheduled for December 18, 2013.

(Edited by Joby Puthuparampil Johnson)

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