RBI raises CRR, repo rate by 50 bps to rein in inflation

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Mumbai, Jun 24: In one of the steepest measures in recent times, the Reserve Bank of India (RBI) on Tuesday launched a frontal attack on inflation by announcing the twin moves of hiking the cash reserve ratio (CRR)— the cash banks must keep with the central bank —and the repo rate, the rate at which banks borrow short-term funds from RBI —by 50 basis points each.

The moves are expected to trigger an across-the-board hike of about 50 basis points in interest rates, with home loan rates also set to go up. The CRR hike will suck out around Rs 17,000-18,000 crore from the system. The stock and bond markets are expected to react sharply when they resume trading Wednesday morning. Yields on 10-year paper are expected to shoot up from 8.56% to around 9%.

In a late evening statement, RBI said CRR was being increased by 50 basis points to 8.75% in two stages. The CRR would be hiked to 8.5% with effect from the fortnight beginning July 5, 2008, while it would be further raised to 8.75% from the fortnight beginning July 19, 2008. Further, the repo rate has been hiked to 8.5% with immediate effect, the central bank said. Inflation had touched a 13-year high of 11.05% when government released figures last Friday, prompting serious confabulations between the government and the central bank on how best to tackle the price situation and temper inflationary expectations.

Immediately after the hike, bankers said they would soon take a call on the quantum of rate hikes to be implemented. Leading mortgage lender Housing Development Finance Corp said the twin measures were bound to push up rates. “Home loan rates may rise by 50 basis points,” Keki Mistry, HDFC MD said.

“Liquidity will be choked as more money from the bank will be mopped up by the RBI due to the CRR hike, that too, without any interest. Our borrowing cost will go up; hence we will take a call on our lending and deposit rates,” said Allan CA Pereira, CMD with Bank of Maharashtra.

“We will also have to check our margins before deciding the rates. Our ALCO meeting is scheduled next Monday to review the rates,” he added. Punjab National Bank’s ALCO meets this week. The executive committee of the State Bank of India, the country’s largest lender, meets in New Delhi on Wednesday.

RBI governor Yaga Venugopal Reddy had, on Monday in Pune, also outlined the central bank’s perceptions on the price situation, making it clear that India would now have to adjust to a new reality and that the high energy prices may not be temporary. RBI, he had said, would continued to take “determined and calibrated” measures with a focus on managing inflationary expectations.

“In view of the criticality of anchoring inflation expectations, a continuous heightened vigil over ensuing monetary and macroeconomic developments is warranted to enable swift responses with appropriate measures as necessary, consistent with the monetary policy stance,” the central bank said on Tuesday, explaining the rationale behind the twin measures on CRR and repo rate. The measures, RBI said, had been taken “consistent with the stance of monetary policy as set out above and on the basis of incoming information on domestic and global macroeconomic and financial developments.”

The detailed statement said important developments had taken place in recent weeks with regard to inflation. “To assess these developments, it is important to recognise the key forces at work. The escalation in inflation last week mainly reflects the pass-through of international crude prices to domestic prices effected on June 5, 2008. Unlike in some mature economies, however, the pass-through is not occurring on a continuous basis in developing economies including India. Thus, the policy response to the escalation in crude prices could be somewhat similar to other countries but tailored to suit our conditions.”

Setting out the backdrop to the measures, the central bank said, besides oil prices, there are some underlying inflationary pressures impacting inflation in India. Inflation, based on variations in the wholesale price index (WPI) on a year-on-year basis, increased to 11.05% as on June 7, 2008 from 7.75% at end-March 2008 and 4.28% a year ago. Excluding the fuel sub-group, inflation rose to 9.61% from 5.92% a year ago. Excluding fuel and food, inflation was 10.33% as against 6.33% in the corresponding period of the preceding year. Inflation based on the consumer price index (CPI) for industrial workers (IW) and urban non-manual employees (UNME) stood at 7.81% and 6.99%, respectively, on a year-on-year basis in April 2008 as compared with 6.67% and 7.74% a year ago. Inflation based on CPI for agricultural labourers (AL) and rural labourers (RL) stood at 9.11% and 8.84% in May 2008, respectively, as compared with 8.22% and 7.90% a year ago.