RBI surprises with 0.5% reverse repo hike

27 Jul 2010

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The Reserve Bank of India (RBI) has been very cautious in its approach to the monetary policy so that growth prospects are not affected much. The policy statement is in line with the market expectations, i.e., RBI announced no hike in CRR and a 25 bps (bps) increase in Repo rate but a 50 bps hike in Reverse Repo rate was not expected by many.

Although RBI has the head room to increase the policy rates even more, we think that the central bank will take a slow and steady approach to increasing rates in the oming months. The introduction of mid-quarter policy review might be a step towards that.

The developed economies have been forced to have an accommodative monetary policy as their economies are still under recovery. Any disruptions in the eveloped world can have a ripple effect to the growth of India and other emerging economies. Therefore, RBI has taken a slow and steady approach to rate hikes despite inflation being in the double digits since February.

Cause and effect
By hiking the Reverse Repo rate, RBI has tried to lower the non-food credit off take which is currently at 22.3 per cent. The current level of credit off take is higher than RBI's projection of 20 per cent for the year. The hike in Reverse Repo is 25 bps more than the hike in Repo rate. This step would lead to banks parking more money with the RBI.
 
Interest rate sensitive sectors like Automobiles, Real Estate, Banking and higher risk lending sectors like Aviation and Capital Goods might face the heat going forward as inflation is expected to remain high in the short to medium-term considering the recent hike in the fuel prices.

Export dependent sectors like IT may also get affected as the Rupee may witness appreciation in the short to medium-term due to the rate hikes as well as capital inflows. RBI also anticipates large inflows into India which can lead to Rupee appreciating considerably.

On 26 July 2010, Moody's rating agency upgraded the local currency government bond rating from Ba2 to Ba1 with a positive outlook, just a notch below the investment grade rating of Baa3. This move is also expected to bring in higher inflows into the country, there by asserting an upward pressure on the Rupee.

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