RBI hikes interest rates by 50 bps

The Reserve Bank of India (RBI) hiked key repo rates and reverse repo rates by 50 basis points ( 1 percent is equal to 100 basis points) on Tuesday at its policy review to tame inflation.

The repo rate, the rate at which the central bank lends short-term money to banks, has been hiked by 0.50 percent to 8 percent and the reverse repo rate, the rate at which the central bank borrows from the banks, has been hiked by 0.50 percent to 7 percent. The cash reserve ratio or CRR remained unchanged at 6 percent.

The RBI’s unexpected decision led to a sharp decline of over 300 points in the BSE Sensex. The 30-share Sensex fell to 18,570 after announcement of the policy, although it had opened in positive terrain. Brokers said investors lost confidence as the Reserve Bank of India’s decision to hike interest rates by 50 basis points in its policy meeting today, was more than the market expected. They said the downfall was led by stocks from banking, auto and realty sectors.

The hike is likely to further dampen the demands for home and car loan which are already the lowest in recent months.

The rate increase is its 11th since March 2010, making the RBI one of the most aggressive inflation fighters among central banks.

Still, wholesale price index inflation was 9.44 percent in June, more than double the RBI’s comfort level, and high prices are expected to persist in coming months.

The RBI, whose forecasts for inflation have proven optimistic in recent quarters, increased its outlook for wholesale inflation at the end of the fiscal year in March to 7 percent, from 6 percent earlier.

“Considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance,” RBI Governor Duvvuri Subbarao wrote in his quarterly policy review.

The RBI stuck with its forecast for economic growth in the current fiscal year of around 8 percent. While some interest-rate sensitive sectors are showing signs of moderating growth, it said, “there is no evidence of a sharp or broad-based slowdown as yet.”

All 23 analysts in a Reuters poll last week had expected the RBI to raise rates by 25 basis points on Tuesday, although 9 of them expected a pause in the tightening cycle after July amid signs of slowing domestic growth and global uncertainty.

Recent industrial output and manufacturing data was the worst in nine months, while sales of cars have slowed sharply and loan demand is easing, complicating the central bank’s inflation-fighting task.

Subbarao said Tuesday’s policy actions are expected to “maintain the credibility of the commitment of monetary policy to controlling inflation.”

The measures are also expected to “reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required,” Subbarao said in his report.

January-March quarter growth was a worse-than-expected 7.8 percent, with economists expecting India to grow at 7.9 percent in the fiscal year that began in April, according to a Reuters poll, less than the 8.5 percent growth in the fiscal year that ended in March.

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