As a surprise to all, the Reserve Bank of India (RBI) in its third quarter review of monetary policy hiked the repo rates or the short term lending rates by 25 basis points (bps) or 0.25 per cent to 8 per cent.
While everyone was expecting RBI to keep rates unchanged after the December inflation data showed signs of easing, RBI increased rates to further back reduction in inflation.
With RBI raising rates, the fear of banks transferring this added burden onto the general public and corporates has shot up. On the one hand, common man is worried about a rise in their EMI payments against home and automobile loans and on the other hand industry is concerned about a rise in their short term borrowings.
While announcing the policy review, RBI Governor, Raghuram Rajan said, “An increase in the policy (repo) rate by 25 basis points is needed to set the economy securely on the recommended disinflationary path.” Consequently, the reverse repo rate under the liquidity adjustment facility will now be revised to 7 per cent and the marginal standing facility rate and bank rate to 9 per cent.
However, the RBI kept the cash reserve ratio unchanged at 4 per cent as liquidity seems to be comfortable. It was widely expected that Rajan would atleast maintain the status quo on rates to support growth.
The central bank also lowered its growth forecast for the current financial year to less than 5 per cent from its earlier forecast of 5 per cent and said inflation will continue to hover around 8 per cent in the next fiscal.
While industry expressed its disappointment, bankers said they will take a view on raising interest rates, depending on demand for credit and other factors. The asset liability committee of the country’s largest lender State Bank of India will review interest rates shortly.
Commenting on whether the banks would also follow the RBI and announce a rate hike, A Krishna Kumar, Managing Director of State Bank of India said, “As of now it (interest rate hike) looks unlikely, but we need to look at the overall data and then take a decision.”
Sl Bansal, Chairman & Managing Director of Oriental Bank of Commerce expressed that they were surprised by RBI’s move as they were expecting a status quo. While talking about its impact, he added, “We will have to take a look at the overall situation and only after then we would be in a position to take a call. We have to see till what extent we can absorb the rate hike and then see if we need to raise interest rates on loans.”
RBI’s announcement were inline with the recommendations with the Urjit Patel committee recommendations, which suggested keeping the consumer price inflation figure as the nominal anchor. The policy statement has several references to the Patel committee and points to the glide path for disinflation suggested by it, wherein the objective is to have an 8 per cent CPI by January 2015 and below 6 percent CPI level by January 2016. Also as per the committee’s recommendations, RBI also announced that henceforth, RBI would conduct monetary policy review after two months gap. The next review is scheduled on April 1.
The policy rate has been increased thrice, by 0.25 per cent each, since Rajan took over as Governor in September. Defending the policy stance, Rajan said a rate cut would not have affected banks or borrowers and that bringing down retail prices is the key to sustainable growth.
“If we cut policy rates, it won’t have any impact on banks’ cost of funds or lending rates for borrowers,” Rajan added. Retail inflation, at 9.87 per cent last month, is expected to be above 9 per cent in the fourth quarter and 7.5-8.5 per cent in Q4 of the next financial year, the RBI said. “Consumer price inflation is too high, we need to bring it down. And we should be able to reach the 8 per cent objective by end of the year with this rate hike,” Rajan added.
Coming as a breather, Rajan did stress that in future monetary would depend on economic data. He said, “The extent and direction of further policy steps will be data dependent, though if the disinflationary process evolves according to this baseline projection, further policy tightening in the near term is not anticipated at this juncture.”
Along with hiking rates, RBI also reduced its growth forecast of FY14. The Governor said economic growth would be below 5 per cent in the current financial year and could accelerate in 2014-15 to a mean projection of 5.5 per cent. He further added that the growth is likely to lose momentum in the third quarter of 2013-14. Economic expansion in the first half of 2013-14 was 4.6 per cent. In order to record a 5 per cent in the full year, second-half growth should be 5.4 per cent.