RBI New Governor Follows Sri Suba Rao

RBI ups repo rate by 25 bps; markets in free fall-Business Line

In his first credit policy since taking over earlier this month, the RBI Governor, Raghuram Rajan, has hiked the key policy repo rate.

The RBI has increased the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.25 per cent to 7.5 per cent with immediate effect.

It has also reduced the marginal standing facility (MSF) rate by 75 basis points from 10.25 per cent to 9.5 per cent with immediate effect. MSF is the rate at which banks borrow from the central bank.

The RBI has reduced the minimum daily maintenance of the cash reserve ratio (CRR) from 99 per cent of the requirement to 95 per cent effective from the fortnight beginning September 21, 2013, while keeping the CRR unchanged at 4.0 per cent.

Consequently, the reverse repo rate under the LAF stands adjusted to 6.5 per cent and the Bank Rate stands reduced to 9.5 per cent with immediate effect. With these changes, the MSF rate and the Bank Rate are recalibrated to 200 basis points above the repo rate.

“The need to anchor inflation and inflation expectations has to be set against the fragile state of the industrial sector and urban demand. Keeping all this in view, bringing down inflation to more tolerable levels warrants raising the repo rate by 25 basis points immediately,” RBI Governor, Raghuram Rajan, said in the mid-quarter policy review statement.

Highlights of the monetary policy review

Stock markets reacted negatively to the policy announcement. The Bombay Stock Exchange's sensitive index Sensex dropped nearly 500 points to a level of 20,155 points at 11.30 a.m, minutes after the announcement. Except software majors - TCS, Wipro, Infosys and pharma major Sun Pharma,which were flat, all other constituents of the index were in the red.

The rupee opened at 62.04, moved up slightly to 61.88 before reversing and trading at 62.38 to the dollar at 11.32 a.m.

Cautious unwinding of exceptional measures

Explaining the rationale for its moves, the RBI said in a statement that it had earlier taken a number of exceptional measures to tighten liquidity with a view to dampening volatility in the foreign exchange market. These had the impact of raising the effective policy rate to 10.25 per cent, and were intended to maintain tight liquidity conditions till there was improved prospects of stable funding took efect. With the improvement in the external environment, the RBI is now in a position to contemplate easing these measures, it said.

Inflation high

Conceding that "inflation is high and household financial savings is lower than desirable", the RBI hopes that a better harvest and negative output gap will help offset the consequences of the currency depreciation and inflation.

Costlier food items sent wholesale price inflation to a six-month high of 6.1 per cent in August.

Growth trailing

Stating that economic growth has weakened with continuing sluggishness in industrial activity and services, the RBI said the pace of infrastructure project completion is subdued and the start of new projects remains muted.

“Consequently, growth is trailing below potential and the output gap is widening. Some pick-up is expected on account of the brightening prospects for agriculture due to kharif output and the upturn in exports,” it said.

Rajan said concerns on the current account deficit have been mitigated by steps taken by the government and the RBI.

Also, steps have been taken to improve the environment for external financing, turning the focus to internal determinants of the value of the rupee, primarily the fiscal deficit and domestic inflation, he said.

“Further actions need not be announced only on policy dates. However, any further change in the minimum daily maintenance of the CRR is not contemplated,” he added.