RBI does the unexpected; hikes repo and reverse repo rates by 50bps

Reserve Bank of India (RBI), stating inflation as dominant macroeconomic concern, has increased the policy rates for 11th time since March 2010. The RBI, in its first quarter review of monetary policy 2011-12, has unexpectedly raised the short term lending and borrowing rates by 50 basis points (bps) each. 

RBI has increased repo rate to 8% from 7.5%, and reverse repo rate to 7% from 6.5%, as a result Marginal Standing Facility (MSF) Rates increased to 9%. MSF rates are determined with a spread of 100 basis points above the repo rates. However, RBI kept Bank Rate and Cash Reserve Ratio unchanged at 6%. The most striking feature of the policy review was that the central bank revising upwards its WPI inflation target to 7% from 6% given earlier. It, however, hopes to contain inflation expectations to between 4 and 4.5% to bring it closer in line with its medium-term target of 3%. Also the RBI has also revised downwards its credit growth target to 18 per cent from 19 per cent for this fiscal and also its M3 target to 15.5 per cent from 16 per cent.

Central bank has maintained its aggressive monetary stance, and expects inflation to remain at elevated level. “Overall, the current balance of global and domestic factors suggests that monetary policy needs to persist with a firm anti-inflationary stance. Moreover, moderating domestic growth will certainly help ease inflationary pressures, which may be reinforced by possible softening in global commodity prices”, the RBI said.

The RBI has kept FY12 GDP growth target unchanged at 8% for the current financial year. RBI in its May 3 Policy Statement projected baseline real GDP growth for 2011-12 at around 8%. This was based on the assumption of a normal monsoon and crude oil prices averaging US$ 110 per barrel. RBI has increased the inflation projection, for the current financial year, by 100bps to 7% from 6% made earlier.
On the financial health of the government RBI said “During April-May 2011, the Central Government’s revenue deficit and fiscal deficit turned out to be higher than the levels during the corresponding period of the previous year reflecting lower revenue receipts and higher expenditure”.

The economic growth has been moderating and this moderation is visible in all the front of the economy. The Industrial registered a growth of 5.7% in the April-May 2011 which is almost half of the growth achieved in corresponding period of last year. This moderation is viewed as the effect of hovering inflation in the economy. The headline inflation for the first quarter of the current fiscal has been above 9%. Inflation for month of April, May and June stood at 9.74%, 9.06% and 9.44% respectively. On the stubbornly high inflation, RBI said, “Although the impact of past monetary policy actions is still getting transmitted, considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance.”
Since March 2010, for the second time, Reserve Bank of India has increased its repo rate by 50 bps; however, it was the fourth time when it has increased the reverse repo rate by 50 basis points. This hike is expected to have negative impact on the investment, credit growth affecting the industrial growth.