Rising inflation coupled with robust IIP data is what seems to have prompted Reserve Bank of India (RBI) to go for a pre-mature rate hike just a month before the next policy meeting scheduled on April 20. RBI has hiked the repo and reverse repo rates by 25 bps on Friday evening after the close of the market hours.
Most of the analysts had already factored in a rate hike in the next RBI policy meeting in April. However, the timing of the latest hikes announced by the apex bank has surprised one and all, including the banking fraternity.
With this latest round of rate hikes in the key short-term lending and borrowing rates, the repo rates currently stand at 5% and reverse repo rates at 3.5%, the apex bank has signaled the banking fraternity towards hardening of lending rates in order to combat rising inflation.
Repo is the rate at which RBI lends to banks and reverse repo is the rate of interest RBI pays to the banks on their deposit sums. When RBI feels that there is excess money in the system, it hikes repo rates in order to stiffen rates and supply of money from its side as a lender body. Thus, repo and reverse repo rates forms a crucial tool for RBI in managing the monetary policy and flow of funds in the system.
The inflation figures for the February stood at 9.89% as compared to 8.56% in the month of January, while the food inflation remains stubbornly high at 16.30% for the week ended March 6, 2010. This may have promoted the apex banking regulator to go for hardening of interest rates.
Usually, RBI resorts to hiking the interest rates when there is substantial demand-side pressure for consumptions of goods and services. By way of rate hikes, RBI aims to suck the excess liquidity out of the system by hardening the interest rates by way of hardening borrowing and lending rates.
However, the high inflation figure of 16.30% for the week ended March 6 is said to be largely on account of higher food prices. It remains to be seen whether the recent rate hike announced by the RBI is effective in curbing the inflationary expectations fuelled by supply-side crunch in food articles.
Interest Rate Trends
|Policy Announcements||Reverse Repo Rate||Repo Rate|
As per the above table, it can be seen as to how RBI has tweaked the repo and reverse repo rates in its monetary policy during the last couple of years.
RBI had adopted a softer stance on the front of interest rate regime starting from December 2008, as can be seen in above chart. This was, precisely, the period when the global recession had started pinching the world economy. During this time RBI had slashed its repo rate by 0.5% and reverse repo rate by 1% from the then month ago figures of November 2008.
With the news of sharp recession in the US and other western economies being confirmed around the time of January 2009, RBI had moved on further to sharply reduce the repo rate by 1% and reverse repo rate to 4%, down 1% from the month of December 2008.
With the latest round of rate hike announced yesterday, one can say that the rate cycle on downside has peaked and has started moving in the opposite direction. The RBI has hiked lending and borrowing rates for the first time since global recession, hinting towards stabilization of domestic economy after witnessing a sharp slowdown post economic crisis around the world.
With the hike announced yesterday, analysts are expecting another 25 bps of repo hike in the upcoming RBI policy meet slated on April 20. It remains to be seen whether this rate hike can curb the rising food inflation, the main threat to the WPI inflation which is on the verge to hit double figures soon.
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