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RBI ups key rates, loans to be costlier

business Updated: Mar 31, 2007 03:36 IST
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The Reserve Bank of India (RBI) raised its short-term lending rate by 25 basis points to 7.75 per cent on Friday, its highest in nearly four and a half years, saying it was critical to take "demonstrable and determined action".

The RBI, which last raised the rate known as the repo rate in January, said it was also increasing its cash reserve ratio, the proportion of cash banks have to keep with it on deposit, by half a percentage point to 6.5 per cent.

"In the light of the current macroeconomic, monetary and anticipated liquidity conditions, and with a view to containing inflation expectations, it is critical to take demonstrable and determined action on an urgent basis," it said in a statement.

Annual inflation is running at nearly 6.5 per cent, as measured by wholesale prices, which is well above the central bank's comfort zone of 5.0-5.5 per cent. Credit growth is also running at about 30 percent annually while money supply is growing at 22 per cent annually. The cash reserve ratio (CRR) increase will take place in two tranches, on April 14 and April 28, and will absorb Rs 15,500 crore from the banking system.

This is the seventh repo rate increase since the central bank began raising the lending rate in October 2005. The RBI's move is expected to squeeze banks' lendable resources by over Rs 14,000 crore and makes it costly for them to borrow from the central bank.

"It will lead to further pressure on liquidity in the banking system. Banks will have to mobilise more deposits to meet credit growth and bring a semblance of balance in their operations," said GV Nageswara Rao of IDBI Bank.

Over the last two weeks, since advance tax payments started, call money — the money banks borrow for a day to meet reserve requirements — rates have shot up to an unprecedented 60 per cent, a sign of the liquidity tightness in the banking system. Banks have to meet CRR requirements daily basis and statutory liquidity ratio requirements every fortnight.

"Inflation hovering around 6.5 per cent for three weeks in a row is cause for concern. The RBI is doing its bit on the monetary front though supply-side constraints are the main reason for the high inflation," said SP Prabhu, senior vice-president, IDBI Capital Market Services.

"The CRR hike also indicates the central bank may feel compelled to intervene in the foreign exchange market to prevent the rupee from appreciating," said another analyst.

The concern on the monetary front is the runaway growth in bank credit, which surging at around 28 per cent for a third year running, pushing the growth of money supply in the economy to 19-20 per cent during the current fiscal year.

(With inputs from agencies)