RBI hikes short term rates to tame inflation

RBI hikes short term rates to tame inflation

The Reserve Bank has raised its short-term lending and borrowing rates by 0.25 pc and 0.50 pc respectively to bring inflation to 6 pc by March 2011 from double digits now, but the move would put pressure on banks' interest rates.

In its monetary review, the central bank, however, kept its cash reserve ratio (CRR), the cash which banks are required to keep with RBI, unchanged.

The RBI raised upwards the inflation target from 5.5 percent to six percent and said that economy will grow by 8.5 percent, up from earlier projection of 8 percent, this fiscal.

The increase in short-term lending rate (repo) to 5.75 percent and short-term borrowing rate (reverse repo) to 4.5 percent will be effective immediately.

Earlier this month, RBI had hiked repo and reverse repo rates by 0.25 percent as inflation remained above 10 percent for the fifth month in succession.

Prior to this, RBI had raised thrice its key rates, since January.

"Inflationary pressures have exacerbated and become generalised with demand side pressures clearly visiblegiven the spread and persistence of inflation, demand-side inflationary pressures need to be contained," the RBI said.

RBI's projection of a higher inflation than the earlier estimate could partly be attributed to the government's move of raising fuel prices.

The central bank said there can be an up to one percent impact on WPI-inflation owing to fuel price hike.

In June, the government raised petrol prices by Rs 3.5 a litre while decontrolling them and hiked diesel prices by Rs 2 a litre, LPG by Rs 35 a cylinder and kerosene by 3 a litre.

The RBI said that the monetary policy stance would be aimed at containing inflation while it will be prepared to respond to any further build-up of inflationary pressures.

Revising upwards the GDP target for this fiscal, the RBI said that indications are that the economy is steadily reverting to its pre-crisis growth trajectory.

However, uncertainty over global recovery could have possible adverse consequences for India, the apex bank said.

If the global recovery slows down, it will affect all emerging market economies, including India, through the usual exports, financing and confidence channels, the RBI said.

A global slowdown also carries the significant risk of a potential slowdown in capital inflows, it said, adding that it may act as constraint to domestic investment.

On liquidity pressures in the system due to payment for spectrum, the RBI said though current market conditions indicate that liquidity pressures will ease, the system is likely to remain in deficit mode "for now".

In another significant move, the RBI said it will now undertake mid-quarter policy reviews, on the lines of major central banks abroad, "to take the surprise element out of the off-cycle actions."

These reviews will be conducted at an interval of about one and a half months, after each quarterly review, the central bank said.

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RBI to have mid-quarter reviews in sync with economic changes

The Reserve Bank decided to come out with mid-quarter monetary reviews so that its swift monetary actions in sync with changing economic conditions do not have a surprise element.

"The Reserve Bank will now undertake mid-quarter reviews roughly at the interval of about one and a half months after each quarterly review. By instituting these, it is our intention to take the surprise element out of the off cycle actions," RBI said in its monetary review released on Tuesday.

As per schedule, mid-quarter reviews will be in June, September, December and March, RBI added.

It further said that the first mid-quarter review of the monetary policy will be announced on 16^th September, 2010, and the quarterly review on 2^nd November, 2010.

The mid-quarter reviews are intended to communicate the RBI's assessment of economic conditions more frequently.

RBI's new move assumes importance since it has been changing its policy rates and other tools ahead of monetary policy or reviews, which are seen by many as unexpected.

Earlier this month, RBI raised short-term lending and borrowing rates by 25 basis points even when it was to announce its monetary review on Tuesday.

This has surprised many, which saw the move as unexpected though warranted to tame high inflation.

Commenting on the RBI's move, Planning Commission Deputy Chairman Montek Singh Ahluwalia said, "Monetary policy is something unlike fiscal policy, which you do for a year. Monetary policy should be adjusted week by week, if necessary. I have never been in favour of fixed dates on which monetary policy changes. Elsewhere in the world, the monetary policy committee meets every two weeks."

RBI further said it will have the flexibility, as always, to take swift ad pre-emptive policy action, as and when warranted by the evolving macroeconomic developments.

Earlier, RBI used to have annual monetary policy and mid-term monetary policy. As economy became dynamic and globalised, RBI started coming out with annual policy and three quarterly reviews.

Now, RBI will have more frequent reviews of its monetary policy.