RBI raises repo, reverse repo rates

The Reserve Bank of India raised interest rates on Thursday for the eighth time since last March by 25 basis points in their Mid-Quarter Monetary Policy Review.

The RBI increased the repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 6.5 per cent to 6.75 per cent with immediate effect; and increased the reverse repo rate under the LAF by 25 basis points from 5.5 per cent to 5.75 per cent with immediate effect.

Repo rate is the rate at which the RBI lends to banks against securities while the reverse repo is the rate it pays to banks for deposits.

The policy action in this Review is expected to continue to rein in demand-side inflationary pressures while minimising risks to growth and manage inflationary expectations and contain the spillover of food and commodity prices into more generalised inflation.

Union Finance Minister Pranab Mukherjee said the hike is good since “it will have its impact on inflationary pressures.”

In its Third Quarter Review, the Reserve Bank had projected year-on-year WPI inflation for March 2011 at 7 per cent.

However, further upside risks have stemmed from high international crude prices, their impact on freely priced petroleum products, the increase in administered coal prices and pick-up in non-food manufactured product prices. The March 2011 WPI inflation is now estimated to be higher – around 8 per cent.

Central Statistical Organisation?s recently released estimate of GDP growth of 8.6 per cent for 2010-11 is consistent with the Reserve Bank?s projection set out in the Third Quarter Review, it said.

The area sown under the Rabi crop is higher than in last year which augurs well for agricultural production, according to the review.

The RBI summed up saying the underlying inflationary pressures have accentuated, even as risks to growth are emerging. Rising global commodity prices, particularly oil, are a major contributor to both developments.

As domestic fuel prices are yet to adjust fully to global prices, risks to inflation remain clearly on the upside, reinforced by the persistence of demand-side pressures as reflected in non-food manufacturing inflation, it said in its review.

The Union Budget for 2011-12 indicates some easing of demand pressures from the fiscal side, thus creating space for private investment, but this will materialise only if commitments to contain subsidies are adhered to.

Measures to increase agricultural productivity, particularly in items facing structural supply-demand imbalances, will contribute to easing food inflation over time, it said.

The RBI said the global scenario presents a mixed picture and while growth in emerging market economies (EMEs) remains strong, that in the US and the Euro area is clearly gaining momentum.

“However, the sharp increase in oil prices as a result of the turmoil in the Middle East and North Africa is adding uncertainty to the pace of global recovery. Further, coming on top of already elevated food and other commodity prices, the spike in oil prices has engendered inflation concerns,” it said.

Inflationary pressures in EMEs are already high as output gaps have narrowed, while headline inflation has risen noticeably in a number of advanced economies, especially in the Euro area and the UK, it said.

Consequently, an increasing number of EMEs have begun monetary tightening, while the debate on exit from the accommodative monetary stance has come to the fore in the advanced economies, the RBI said.