The Reserve Bank of India on Tuesday raised its key policy rate, for the second time in as many months, in a bid to tame inflation that has been high and sticky for several months.
Despite the risks to an already sluggish economy, the central bank increased the repo rate — the rate at which it lends to commercial banks — from 7.5% to 7.75%.
“It’s important to curb inflation and inflationary expectations. This will help create an environment of growth,” new RBI chief Raghuram Rajan, a high-profile former chief economist at the International Monetary Fund, said.
The hike was in line with what most analysts and experts had predicted and the markets reacted positively as Rajan left the cash reserve ratio (CRR) — the percentage of deposits banks must hold in cash with the central bank — unchanged at 4%.
The rupee strengthened and bonds gained. The rupee had risen to 61.52 per dollar from around 61.63 before the RBI decision.
The rupee had slumped to record lows in August, at one point sliding some 20% for the year, on concerns about the country's gaping current account and fiscal deficits, and as global investors dumped emerging market assets for fear the US Federal Reserve was set to start tapering its massive stimulus programme.
Rajan, who took office in early September, had stunned markets in his first policy review just weeks later by raising interest rates to combat fierce price pressures dogging Asia’s third-largest economy.
Most economists had predicted Tuesday’s hike by Rajan, as wholesale inflation has been above the RBI's comfort zone of 5% for four successive months.
India's annual inflation jumped to a seven-month-high of 6.46% for the month of September, led by surging food and fuel prices.
For Indian consumers, it is double-whammy as they battle rising inflation squeezing their real incomes, while higher interest rates leave them with bigger EMIs on home loans and less to save or spend on other things
Annual food inflation accelerated to 18.4% in September, its highest since mid-2010, pushed up by prices of vegetables including onions and stirring public discontent ahead of national elections which must be held by next May.
Samiran Chakraborty, head of research at Standard Chartered in Mumbai, had on Monday said, “Given that food price inflation is at a 38-month high, there is a risk that it could spread to generalised inflation expectations."
In this challenging scenario, Reserve Bank-sponsored professional forecasters on Monday had scaled down India's growth projection to 4.8% for the current fiscal from 5.7% estimated earlier.
Highlights from Rajan's press conference in Mumbai:
Following are the highlights of theRBI's second quarter review of monetary policy 2013-14:
• Repo or short-term lending rate up by 0.25% to 7.75%.
• Cash reserve ratio unchanged at 4%.
• Marginal standing facility (MSF) rate cut by 0.25% to 8.75%.
• Difference between repo and MSF rate narrows to 1%.
• Repo hiked due to upturn of inflation, other factors.
• Wholesale inflation expected to be higher than current levels; warrants 'appropriate policy response'.
• Retail inflation to hover around 9%.
• Food price pressures may ease with the arrival of summer crop harvest and seasonal moderation.
• Prospect of delay in taper of US Fed Reserve's bond purchases has brought calm to financial markets.
• Normalcy will restored in the forex market only when OMCs fully return to the market for their demand.
• FY14 GDP growth estimate revised downward to 5% vs 5.7%.
• Growth likely to pick up in second half on good show in exports and agriculture.
• Liquidity pressures building on small businesses as large entities holding on payments; remedies lie in speeding-up of Government and PSU payments.
• Average drawdown from MSF has declined to Rs 0.4 trillion by mid-Oct, down from a high of Rs 1.4 trillion in mid-September.
• Final guidelines on unhedged forex exposures by corporates to be out by December.
• Jalan panel on new bank licenses to hold 1st meet on Nov 1, decision of RBI on in-principle approvals will be final.
(With inputs from agencies)