RBI hikes rates further to tame inflation

RBI Governor D Subbarao, who unveiled the policy here, hiked the repurchase (repo) rate and the reverse repo rate by 25 basis points each. At the same time, he also increased the cash reserve ratio to 6 percent from 5.75 percent earlier.

The repo rate, which was 5 percent prior to Tuesday's revision, is the interest charged by the central bank on borrowings by commercial banks. A hike in this rate increases the cost of borrowing for commercial banks.

The reverse repo, which stood at 3.5 percent, is the rate at which the central bank borrows money from commercial banks. A hike in this rate makes it more lucrative for banks to park its funds with the RBI.

The new rates were unveiled by Subbarao before chief executives of commercial banks. He said the revised repo and reverse repo rates are effective immediately, while the cash reserve ratio is to take effect from the week beginning April 24.

Reacting to the monetary policy, Finance Minister Pranab Mukherjee said it signalled a move toward neutral policy rates - one that helps tame inflation but also ensures that the country's growth momentum does not suffer on account of a credit squeeze. "This policy should have a gentle impact in tightening money in the economy and should dampen further inflationary pressures," Mukherjee told reporters here, soon after the policy was unveiled by the central bank.

On the issue of inflation, the Finance Minister said it was difficult to predict the actual outcome in the long-run and depended on a combination of some statistical analysis and intuition. "But my own belief based on analysis done in my ministry is that inflation is now on a downward trajectory and in 2010-11 will be less than 5.5 percent and, in fact, closer to 4 percent with an upward bias."

The key policy rates and credit ratios announced by the central bank are:

Bank rate: 6 percent

Repurchase (repo) rate: 5.25

Reverse repurchase rate: 3.75

Cash reserve ratio: 6 percent

Statutory liquidity ratio: 25 percent

According to the central bank, the hike in cash reserve ratio was expected to suck out some Rs 12,500 crore ($2.75 billion) out of the system. The hikes in the policy rates will also impact on the amount of funds available for commercial credit. "The economy is recovering rapidly from the growth slowdown but inflationary pressures, which were triggered by supply side factors, are now developing into wider inflationary process," Subbarao said. "As the domestic balance of risks shifts from growth slowdown to inflation, our policy stance must recognise and respond to this transition."

The industry, by and large, welcomed the measures announced in the monetary policy. "It is the best bargain in the prevailing situation," said Amit Mitra, secretary general of the Federation of Indian Chambers of Commerce and Industry (FICCI).

"The monetary policy has suggested and supported the government strong feeling to sustain the growth momentum," said Swati Piramal, president of the Associated Chambers of Commerce and Industry (Assocham).

"We believe the RBI is aware of the challenges faced by industry at a time when credit growth is picking up and capacity expansions are taking place," added Chandrajit Banerjee, director general of the Confederation of Indian Industry (CII).