RBI hikes repo, reverse repo rates by 25 bps

The Reserve Bank of India (RBI) today raised key policy rates by 25 basis points (bps) to mark a reversal of its easy monetary policy regime to tame inflation and anchor inflationary expectations.

In a statement, the central bank said that the repo rate, or the rate at which banks borrow from the RBI, is being increased by 25 bps to 5 per cent. Similarly, the reverse repo rate, which is the rate at which surplus cash is parked with the central bank, was also increased to 3.5 per cent, from 3.25 per cent earlier.

This is the second action since January when RBI had announced a 75-bps rise in the cash reserve ratio to 5.75 per cent. But unlike CRR, which is used to manage liquidity in the system, an increase in the repo and reserve repo rates is aimed at signaling an increase in interest rates.

This is the first increase in policy rates since July 2008 when the repo rate was increased by 50 bps. The reverse repo was last hiked in June 2006, when the RBI raised the rate by 25 bps. Since October, the RBI started a process of reduction in interest rates and lowered the CRR to inject liquidity in the system to spur economic growth.

However, its latest move comes in the backdrop of rising inflation which touched 9.89 per cent in February and is projected to touch double-digit level next month. The RBI drew comfort from the economic recovery gaining momentum and pointed to the robust industrial growth, exports turning positive and a sustained increase in bank credit and resource mobilisation by the commercial sector from non-bank sources.

Though RBI Deputy Governor Subir Gokarn had initially suggested that the central bank would prefer to wait till April, when the annual policy is due, to raise rates, an indication of a change in stance came yesterday, when K C Chakrabarty, another deputy governor, said that RBI had kept all options open.

“Our assessment is that  at the this juncture further policy action is warranted. Given the lags in monetary policy, it is better to respond in a timely manner, even if it is outside the scheduled policy reviews, than take stronger measures at a later stage when inflationary expectations have accentuated,” the statement said.

It said these measures will anchor inflationary expectations and contain inflation going forward. “As liquidity in the banking system will remain adequate, credit expansion for sustaining the recovery will not be affected… The Reserve Bank will continue to monitor macroeconomic conditions, particularly the price situation, and take further action as warranted," the statement added.

While banks increased lending and deposit rates following the increase in CRR, they are expected to wait till next month before finalising on the next round of increase. "The RBI wants to manage demand-linked inflation trend. There may not be an immediate rise in lending rates as just 10 days are left for the close of this financial year. Banks will wait for further signals from the central bank before they decide on increasing lending rates,” said R S Reddy, chairman and managing director, Andhra Bank.

“There has already been some pre-emptive action by banks on deposit rates and the latest rate hike will not warrant any significant ALCO (Asset liability committee) strategy changes. It will normalize market interest rates,” Yes Bank Chief Executive Officer and Managing Director Rana Kapoor said.

“The rate hike action has come as a surprise. The market did not expect RBI to act before the annual policy. The yield on government bonds may rise by up to 15 bps on Monday. The hardening of yields is here to stay,” said B Prasanna, CEO & MD ICICI Securities Primary Dealership.
  

Chanda Kochhar, MD & CEO, ICICI Bank
Currently there is ample liquidity in the market. We need to wait and see the credit offtake and systemic liquidity to assess the medium term impact on lending and borrowing rates.

Rana Kapoor, MD & CEO, Yes Bank
Yield on government bonds will soften because the money market was expecting a far steeper and sharper rise. It is a prudent move on RBI’s part to change rates a month before the next monetary policy because it takes the uncertainty out of the market. There has already been some pre-emptive action by banks on deposit rates and the latest rate hike will not warrant any significant ALCO (asset-liability committee) strategy changes. It will normalize market interest rates.

Neeraj Swaroop, CEO (South Asia), 
Standard Chartered Bank
The rate hike is primarily a signal. The move will definitely help RBI's efforts to arrest inflation.

S S Ranjan, CFO, SBI
It is signal from RBI that money will be costlier.

S K Goel, CMD, Uco Bank
There will be some pressure on liquidity. But RBI had to take this step to control inflation. We will see how liquidity behaves in the next 15 days and then take a call on interest rates.

B Prasanna, MD & CEO, 
ICICI Securities Primary Dealership
The rate hike action has come as a surprise. The market did not expect RBI to act before the annual policy. The yield on government bonds may rise by up to 15 basis points on Monday. The hardening of yields is here to stay.

RS Reddy, CMD, Andhra Bank
RBI wants to manage demand-linked inflation trend. There may not be an immediate rise in lending rates as just 10 days are left for the close of this financial year. Banks will wait for further signals from the central bank before they decide on increasing lending rates.

Bhaskar Sen, CMD, United Bank of India 
While this step has been taken to manage inflationary expectations, there will be a concern over bond valuation emerging from a rise in the repo rate