Life for the EMI-hit borrower just got tougher. Sharpening its ongoing attack on inflation, the Reserve Bank of India (RBI) on Tuesday hiked the cash reserve ratio (CRR)?the proportion of deposits a bank must maintain with the central bank?by 25 basis points. This is expected to suck Rs 9,000 crore out of the system.

RBI also hiked the repo rate?the rate at which it lends short-term money to banks?by a steep 50 basis points. This will leave banks with very little option but to raise lending rates further. CRR now stands at a hefty 9%, with effect from the fortnight beginning August 30, 2008, the highest since 1999. The repo rate will also stand at 9%. The reverse repo rate and the bank rate, however, remain unchanged.

In the first quarter review of its Annual Statement on Monetary Policy for 2008-09, RBI described the present 11.89% rate of inflation as an ?intolerable level?. RBI governor Yaga Venugopal Reddy made it clear that ?liquidity management will continue to receive priority in the hierarchy of policy objectives over the period ahead.?

This, he said, was in view of the evolving environment of ?heightened uncertainty? in global markets and the dangers of potential spillovers onto domestic markets. The central bank said policy actions would aim to bring down current levels of inflation to a ?tolerable? below 5% as soon as possible, and to around 3% over the medium term.

It said that at this juncture, a realistic endeavour would be to bring down inflation from the current 11-12% to close to 7% by March 31, 2009. RBI also revised its GDP estimate downward for 2008-09, from the earlier 8-8.5% to around 8%, ?barring domestic or external shocks?.

RBI thinks inflation, not its rate hikes, will impact growth. The RBI governor said the central bank?s view was if inflation were allowed to continue at these levels, growth itself would be disrupted. ?If the idea is that because of the stern measures on inflation, growth could be affected with a one-year lag, I would say if we do not take stern measures now, it could lead to such inflation that it might disrupt growth,? Reddy explained.

Stock and money markets reacted sharply to the measures. The 30-share BSE Sensex tanked a hefty 557.57 points, while the yield on the 10-year government bonds shot up to 9.51% before settling at 9.40% at the end of the day, up from Monday?s 9.07%. Almost on cue, some banks have already made it clear that RBI?s measures would force them to re-look their rates and revise them upwards.

The managing committee of the Indian Banks? Association (IBA), which met immediately after the policy review, felt that while lending rates would have to be raised, deposit rates might have to wait, owing to market competition. IBA also sees a further tightening in monetary policy in the days ahead.

KC Chakrabarty, chairman & managing director of state-run Punjab National Bank, said: ?We are definitely going to hike our lending and deposit rates, and also housing loan interest rates in the near future. Our asset liability committee (Alco) is meeting on July 31 to chalk out a strategy.?

ICICI Bank joint managing director & CFO Chanda Kochhar said, ?The lending and deposit rates would surely go up now. Our housing portfolio, as well as the retail credit segment, is expected to grow at 5-10% and corporate credit off-take might grow at 15-20% in the current fiscal. Obviously, the number of real estate transactions has gone down in the past. That is going to affect the home loan business of Indian banks.?

With the rate hikes, banks will also feel the pinch on their cost of funds, and also on the treasury side, with bond yields also surging. Already, several major banks have had to take a big hit on their bond portfolios in the first quarter of FY09 owing to a spike in interest rates. This is bound to intensify in coming days.

Said MD Mallya, chairman & managing director, Bank of Baroda: ?Our Alco is meeting later this week to take a call on our lending as well as deposit rates. I do not expect a huge demand for housing credit in the next few months due to the prevailing high interest rates. Today?s hike in CRR will suck out Rs 300 crore from my bank. Thus, the pressure on the bank?s profitability could be as high as Rs 2-2.5 crore a month.?

Bank treasury heads are also weighing the impact of the latest round of rate hikes, to assess the hit banks could take on the mark-to-market side. Conceding that the bottomlines of banks would be hit on account of the bond portfolio, Ashish Parthasarthy, head of trading at HDFC Bank, said G-sec yields could go up to 10%. ?It would thus further deepen the mark-to-market loss of Indian banks in the second quarter of this fiscal.?

But governor Reddy virtually brushed aside concerns that banks? profitability would take a hit at his customary post-policy review press conference. Said Reddy: ?All I can say is, every time medicine is given, and people have considered it to be bitter, in the end they have turned out to be healthy.?

Analysts admitted that Reddy?s tough stance on rates took them by surprise. Said Robert Prior-Wandesford, head of the Asian economics team at HSBC: ?RBI traditionally likes to spring a surprise and today?s decision was no exception as it continued in its attempt to temper price and wage expectations.?

?We had been looking for quarter-point increases in CRR and repo. Since resuming the tightening cycle in April this year, the bank has now delivered 150 bps of CRR hikes and 125 bps of repo rate hikes–a meaningful move and one which will see commercial banks raise their lending rates further,? Prior-Wandesford added.

Significantly, RBI also said it had ?headroom available? in terms of the flexibility to deploy instruments, complemented by prudential regulations and capital account management. RBI said money supply (M3) grew 20.5% on a year-on-year basis on July 4, 2008, lower than the 21.8% a year earlier.

Up until July 4, non-food credit of scheduled commercial banks rose 25.9% on a y-o-y basis, higher than 24.6% a year earlier.