RBI warns of tough times, raises key rates by 50 bps

Warning of tough times ahead, the RBI today raised the key short term lending rate and savings bank rates by 50 basis points (bps) and advised the government to hike petroleum prices as soon as possible in line with the ruling global crude prices.

In view of uncertainity prevailing in the global market, the RBI, while announcing its annual Credit Policy, has pegged the growth outlook for 2011-12 at a lower level of 8% as against the government's projection of 9%.

The RBI's decision to increase its lending (repo) and borrowing (reverse repo) rates by 50 basis points to 7.25% and 6.25% respectively will raise the cost of home, auto and other loans.

"Current elevated rate of inflation pose significant risk to future growth. Bringing them down, therefore, even at the cost of some growth in the short run should take precedence," RBI Governor D Subbarao said.

The current inflation is hovering around 9%, much above the RBI's confort level of 5-6%.

Commenting on the RBI policy, Finance Minister Pranab Mukherjee said "this (rate hike) was necessary to contain inflation. Inflationary pressures to the economy is still very high".

The RBI, however, gave much required relief to general depositors by increacing the savings bank rate to four% from 3.5% now. This would also have a bearing on the lending rates of the banks.

Making a strong case for increasing the petroleum prices in line with the global crude prices, the RBI said that any delay would widen the fiscal deficit and counter the moderating trend in aggregate demand.

"Even though an adjustment of domestic retail prices may add to the inflation rate in the short run, RBI believes this needs to be done as soon as possible. Otherwise, the fiscal deficit will widen and will counter the moderating trend in aggregate demand," Subbarao said.

He stated that FY12 Oil and Fertiliser subsidies to be key area of concern.

Justifying the hawkish policy stance, the RBI said "resurgence of inflation in the last quarter of last year became a matter of concern".

Subbarao further said the recent surge in global commodity prices are likely to continue during the course of the year. "This suggests that higher inflation will persist, and may get worse".

While raising the key policy rates, the RBI retained the bank rate at 6% and  the Cash Reserve Ratio (CRR) also at 6%. The CRR is the portion of deposits the banks are required to park with the RBI.

Retaining CRR at 6% would ensure sufficient liquidity in the system.

The Central Bank has pegged the March 2012 inflation at 6% with an upward bias. "As regards the trajectory over the year, inflation is expected to remain at an elevated level in the first half of the year before gradually moderating to 6% by March 2012," it added.

The RBI also introduced a new mechanism, Marginal Standing Facility, under which banks would be permitted to borrow short term funds up to 1% of their deposits at 8.25%.