RBI resumes tightening...hikes rates by 25 bps

The Reserve Bank of India (RBI) increased the key policy rates by 25 basis points (bps) each, as the central bank stepped up its efforts to tackle a stubbornly high inflation at the cost of some moderation in economic growth. The repurchase rate (repo rate) was hiked by 25 bps to 6.50%, while the reverse repo rate was also increased by 25 bps to 5.50%. The central bank also extended the 1% leeway in the SLR up to April 8. CRR was left unchanged at 6%. The inflation target for FY11 was increased to 7% from 5.5% earlier while the GDP forecast for the current fiscal year was kept steady at 8.5% with an upward bias.



The RBI raised key policy rates six times last year as the Indian economy accelerated, sending inflation sharply higher. But several factors, including unseasonal rains and spike in global commodity prices has kept inflation elevated. Dr. D. Subbarao, Governor of the RBI decided to take a pause in its last meeting on December 16 amid a severe shortage of cash in the banking system and some softening in food inflation. Inflation shot up to 8.43% in December, from 7.48% in the previous month, the Government said on January 14. October's inflation rate was revised to 9.12% as against the provisional estimate of 8.58%. Inflation in the Food Articles group rose to 15.57% in the week ended January 15 from 15.52% in the week ended January 8, the Commerce & Industry said on January 27.

The RBI said that the new actions are expected to:

* Contain the spill-over from rise in food and fuel prices to generalised inflation.
* Rein in rising inflationary expectations, which may be aggravated by the structural and transitory nature of food price increases.
* Be moderate enough not to disrupt growth.
* Continue to provide comfort to banks in their liquidity management operations.

The next mid-quarter review of the Monetary Policy for FY11 will be announced through a press release on March 17, the RBI said. The Monetary Policy for FY12 will be announced on Tuesday, May 3.

The RBI began exiting from the global financial crisis driven expansionary monetary policy as early as in October 2009. Since then, it has cumulatively raised the CRR by 100 bps, and the repo rate and the reverse repo rate by 150 bps and 200 bps, respectively. As the overall liquidity in the system has transited from a surplus to a deficit mode, the effective tightening in the policy rate has been of 300 bps.

Current growth and inflation trends warrant persistence with the anti-inflationary monetary stance, the RBI said. Looking beyond FY11, the RBI expects domestic growth momentum to stabilise, though the GDP growth rate may decline somewhat as agriculture reverts to its trend (assuming a normal monsoon), it added. Inflation is likely to resume its moderating trend in the first quarter of FY12, but several upside risks are already visible in the global environment and more may surface domestically, the RBI said. The monetary stance will be determined by how these factors impact the overall inflationary scenario, the RBI said.

For the fiscal consolidation process to be credible and effective, it is important that apart from augmenting revenue, the composition and quality of expenditure improves, the central bank said. Any slippage in the fiscal consolidation at this stage may render the process of inflation management even harder, it added. The frictional liquidity shortage is expected to ease as Government balances adjust to the expenditure schedule, the RBI said. However, banks need to focus on the underlying structural cause of liquidity tightness arising out of the gap between the credit and deposit growth rates, it said.