Inflation warrior Raghuram Rajan raises repo rate by 25 bps, eases rupee defence

Written by fe Bureau | Mumbai | Updated: Oct 30 2013, 13:48pm hrs
The Reserve Bank of India (RBI) on Tuesday stayed focused on taming inflation, raising the key repo rate by 25 basis points to 7.75% while simultaneously taking the sting out of the rate hike by easing liquidity and unwinding special measures intended to support the rupee.

The central bank also pared its GDP growth projection for the current year to 5% from 5.5% and, for the first time, offered a projection for consumer price inflation (CPI), saying it expects CPI to remain around or even above 9% in the months ahead, absent policy action.

Explaining his policy stance, RBI governor Raghuram Rajan /b> said it was important to break the spiral of rising price pressures in order to curb the erosion of financial savings and strengthen the foundations of growth. Curbing mounting inflationary pressures and managing inflation expectations will help strengthen the environment for growth by fostering macroeconomic and financial stability. The Reserve Bank will closely monitor inflation risk while being mindful of the evolving growth dynamics, Rajan said.

The RBI believes better exports along with an uptick in some services and agriculture could support a pick-up in growth in the second half of FY14. It also expects the revival of large stalled projects to buoy investment activity towards the close of the year.

Bankers comments on the direction of interest rates were cautious. Arundhati Bhattacharya, chairperson, State Bank of India (SBI), said: I think there will be some change in rates. Which way and what, you will have to wait for the ALCO meetings to happen. Bhattacharya confirmed the banks ALCO would meet over the next 24 hours.

The cost of funds would have gone up over the last three months and as we are now going back to the normal monetary policyover a period of time, it would come down, Aditya Puri, MD and CEO, HDFC Bank, observed.

While the RBI chose not to give a clearer guidance of future rate action, another round of interest rate hikes is not being ruled out. What we have said is that we are comfortable with where we are based on the environment we see as well as the projections we have made on the evolving path of the economy. Going forward, if the data comes in any different stronger or weaker obviously, we will have to take steps accordingly, the governor said.

Sonal Varma, economist at Nomura observed that with CPI inflation close to 9.5% and deposit rates in the range of 8-9%, a positive real return to savers would call for a further hike in the repo rate. We expect another 25 bps hike in the repo rate to 8% by March 2014, Varma said.

Stock and bonds rallied the Sensex surged 359 points while the yield on the benchmark bond dropped 10 basis points to 8.56%. While the RBI has hiked rates in response to inflation, theres no indication it will go hammer and tongs and that suggests a neutral stance on future policy, Hitendra Dave, MD and head of global markets (India) at HSBC said.

NS Venkatesh, head treasury at IDBI Bank said allowing banks to borrow at a slightly higher rate, through term repo operations, would ensure additional liquidity was used for productive purposes.

C Rangarajan, chairman of the Prime Ministers Economic Advisory Council said in a television interview further hikes would depend on inflation. If inflation rises, the RBI may need to raise rates further, Dr Rangarajan said. Completing the unwinding of measures announced to support the rupee, in July this year, the central bank dropped the marginal standing facility (MSF) rate by 25 bps to 8.75%. This will ease the cost of funds for banks who have been borrowing from this window.

While the RBI left the cap on bank borrowings from the liquidity adjustment facility (LAF) unchanged banks can borrow from this window at 7.75% it has allowed lenders to borrow up to 0.5% of total deposits from the recently introduced seven-day and 14-day term repo operations. This will infuse an additional Rs 20,000 crore into the system at a cost between the repo rate of 8% and the MSF rate of 9%.

With external sector and currency concerns easing, the central banks focus has returned to inflation which remains above its comfort level. Wholesale price inflation is also expected to remain higher than current levels through the rest of the year, the RBI noted, pointing out that despite the expected easing in food prices, CPI is expected to remain near 9% levels as well.

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, said the RBI in its policy statement suggesting that its focus remains on fighting inflation. Despite the prospect of future rate hikes, bank stocks rallied in anticipation of a reduction in cost of funds due to the cut in the MSF rate and the additional liquidity infusion. Cumulatively, banks will now have access of Rs 1,20,000 crore in liquidity between the LAF, term repo and export refinance windows. Only if the liquidity deficit overshoots that, will banks need to access the MSF window at the peak rate of 8.75%.