labels: rex mathew, rbi, economy - general, governance
RBI surprises with 25 bps interest rate hikenews
Rex Mathew
24 January 2006

The Reserve Bank of India today raised key short term interest rates by 25 basis points, as predicted in last Saturday's Weekly Round up. The reverse repo rate, the rate at which RBI borrows from the market, has been increased from 5.25 per cent per annum to 5.5 per cent. The repo rate, the rate at which RBI lends short term funds to commercial banks has been hiked from 6.25 per cent to 6.5 per cent per annum.

The bank rate, mostly used as a reference rate, has been left unchanged at 6 per cent per annum. The cash reserve ratio, the percentage of deposits commercial banks need to keep as cash and cash equivalents, has also been left unchanged.

Most economists and debt market participants expected the RBI to keep interest rates stable. Inflation is very much under control at between 4 and 4.5 per cent and in all likelihood would meet the RBI's target of between 5 and 5.5 per cent by March end. It was also felt that there would be some political pressure on the central bank to keep low interest rates to facilitate faster economic growth rates.

However, the RBI seems to be more concerned about sustaining the economic growth rates over a longer term rather than pushing them up further in the short term. The bank has clearly stated that the risk of higher inflation remains and the latest surge in crude prices may have forced its hand.

The RBI has raised its GDP growth forecast for the current year to between 7.5 and 8 per cent. The bank also said that global growth rate for the current year could be higher than the IMF forecast of 4.3 per cent. In view of the accelerated growth both domestically and globally, it is not very surprising that the RBI has taken the precautionary step of raising interest rates to keep inflation under check.

As credit growth for the commercial banks has remained strong, the RBI is also concerned about the higher credit risks the banking sector is taking, especially in the retail and real estate segments. The central bank had asked banks to be more discerning in credit approvals many times in the recent past and higher interest rates would ensure that borrowers are more judicious.

Impact on consumer and corporate credit
Some of the larger banks had raised both deposit and lending rates in recent weeks even before the RBI policy announcement. While most banks have announced that they are evaluating the situation after the rate hike announcement, some of them have declared a hike in deposit rates.

Interest rates on deposits were going up anyway as banks are finding it difficult to attract deposits. The interest rates on corporate lending may harden marginally, but is unlikely to be significant enough to impact corporate profitability.

The rates on consumer credit may finally see some firming up. HDFC had announced a rate hike for home loans early this month and has stated today that it may consider another hike in the near future. Some of the PSU banks have announced a home loan rate hike today. The home loan segment may see the maximum impact as banks can pass on higher rates because of very strong demand.

Rates on other types of consumer finance may also go up, though to a less extent. Strong competition among banks in retail consumer finance and entry of strong non-banking players would keep the rates in this segment under check.

also see : Third quarterly review of annual monetary policy for 2005-06

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RBI surprises with 25 bps interest rate hike