RBI raises interest rate by 50 bps

The RBI on July 26 hiked short-term lending and borrowing rates sharply by 50 basis points for the third time in three months to tame high inflation, a move that would make all personal and corporate loans more expensive.

The RBI has also revised its fiscal-end inflation projection to 7 per cent from 6 per cent earlier.

With July 26 increase of 0.50 per cent, the short-term lending (repo) rate has been hiked to 8 per cent and the short-term borrowing (reverse repo) rate has also been increased by a similar margin to 7 per cent.

It, however, has retained the cash reserve ratio (CRR) at 6 per cent.

“Notwithstanding signs of moderation, inflationary pressures are clearly very strong... inflation continues to be the dominant macroeconomic concern. On the basis of this assessment, it has been decided to increase policy repo rate by 50 basis points from 7.5 to 8 per cent with immediate effect,” RBI Governor D. Subbarao said while announcing the quarterly review of the monetary policy. 

Eleventh time

This is the 11th time since March, 2010, that the RBI has raised the interest rate to check inflation, which is currently ruling at over 9 per cent.

The RBI’s unexpected decision led to a sharp decline of over 300 points in the BSE Sensex. The 30-share Sensex fell to 18,570 after announcement of the policy, although it had opened in positive terrain.

The RBI admitted that its cumulative decision of past actions to curb demand and anchor medium term inflationary expectations will curtail growth in the near term. 

Impact on interest rates

Bankers are of view that the increase in key policy rates by the RBI will definitely have an impact on interest rates, leading to loans becoming expensive.

“The hike is more than expected and it will push interest rate by up to 50 basis points,” said Oriental Bank of Commerce Executive Director S C Sinha.

In the annual policy on May 3, the apex bank had increased policy rates by 50 bps, which was followed by a 25 bps hike at its mid-quarter review in June.

While revising the inflation target upward, Dr. Subbarao reiterated the RBI’s view that the policy is guided by uncomfortable inflation, which hovers well above 9.4 per cent. 

On domestic and global growth

Sounding hawkish, the Governor said, “Going forward, the monetary policy stance will depend on the evolving inflation trajectory, which in turn will be determined by trends in the domestic growth and global commodity prices.

“A change in stance will be motivated by signs of a sustainable downturn in inflation,” Dr. Subbarao said.

Accordingly, the RBI, which has been at the receiving end for its repeatedly off-mark inflation projections, also revised its fiscal-end inflation forecast upward by 1 per cent to 7 per cent from its 6 per cent estimate made earlier in May.

Admitting that there has been a moderation in growth, the Governor maintained his previous estimate of 8 per cent GDP growth for the current fiscal and pointed out downside risks to growth as global commodity prices, the uncertain global macro economic environment and the Centre’s inability to meet the fiscal deficit target of 4.6 per cent on the back of a rising fuel subsidy bill.

“Overall, the current balance of global and domestic factors suggest that monetary policy needs to persist with a firm anti-inflationary stance,” the governor concluded.