In its first quarterly review of the monetary policy for 2008, the Reserve Bank of India today raised its key lending rate, the repo rate, by 50 basis points to 9.0 per cent, its third hike in two months, and the CRR by 25 bps to 9 per cent in a bid to mop up excess liquidity from the banking system. The CRR is the funds banks must keep on deposit with RBI.

The RBI has left the bank rate and reverse repo rate under LAF unchanged.

Last month it had raised the repo rate twice totalling 75 basis points - first by 25 bps on on 11 June and again on 23 June by 50 bps, taking it up to 8.5 per cent, accompanied by a two-stage raising of the CRR to 8.75 per cent. The increase will take effect tomorrow, 30 August.

"The tightening was stronger than expected-we and the consensus were expecting 25 bp on the repo and 25 bp on the CRR," says  Tushar Poddar, vice president Asia economic research, Goldman Sachs, which expects the higher interest rates to slow investment demand and growth, with the impact felt particularly in FY10. We have recently lowered our GDP growth forecasts for FY10 to 7.2 per cent from 8.2 per cent due to the weaker investment outlook.

Poddar adds, "We expect a tightening bias will remain in policy in the near term and now expect a hike of 25 bp in the repo rate and the CRR respectively by end-October. We think, however, that rates will start easing from 1Q2009 as inflation begins to come off. As the credit cycle is turning, we think that the central bank will need to increasingly prepare for a downturn in credit and asset quality issues."

With today's increase, the RBI's short-term lending rate is at a nearly eight-year high, in a bid to manage rising inflation, which at nearly 12 per cent is at a 13-year peak, prompting the RBI to resume interest rate increases after a pause of more than a year.

The repo rate is at 9 per cent for the first time since October, 2000, while CRR is at 9 per cent for the first time since November, 1999.

The RBI said inflation has emerged as the biggest risk to global outlook and bringing down inflation is the highest priority. RBI aims to bring down inflation to 5 per cent as soon as possible and endeavours to lower it to 7 per cent by March 2009.

The RBI says it has more than anticipated moderation in industrial and services sector and has revised its GDP growth projection for 2008-from the range of 8.0 - 8.5 per cent to around 8.0 per cent, "barring domestic or external shocks".

It said in a satement, "While the policy actions would aim to bring down the current intolerable level of inflation to a tolerable level of below 5.0 per cent as soon as possible and around 3.0 per cent over the medium-term, at this juncture a realistic policy endeavour would be to bring down inflation from the current level of about 11.0-12.0 per cent to a level close to 7.0 per cent by March 31, 2009."

The statement added that while there are early signs of some moderation in money supply and deposit growth, "they continue to expand above the indicative projections warranting continuous vigilance and appropriate and timely policy responses".

for the RBI its liquidity management will continue to receive priority "in the hierarchy of policy objectives" in the coming months, in view of the "evolving environment of heightened uncertainty in global markets and the dangers of potential spillovers to domestic markets".

The bank also said that barring the emergence of any adverse and unexpected developments in various sectors of the economy, assuming that capital flows are effectively managed, and keeping in view the current assessment of the economy including the outlook for growth and inflation, the overall stance of monetary policy in 2008-09 will broadly continue to be:

• To ensure a monetary and interest rate environment that accords high priority to price stability, well-anchored inflation expectations and orderly conditions in financial markets while being conducive to continuation of the growth momentum.
  
• To respond swiftly on a continuing basis to the evolving constellation of adverse international developments and to the domestic situation impinging on inflation expectations, financial stability and growth momentum, with both conventional and unconventional measures, as appropriate.
  
• To emphasise credit quality as well as credit delivery, in particular, for employment-intensive sectors, while pursuing financial inclusion.

(See: Highlights of the First Quarter Review of Annual Statement on Monetary Policy for the Year 2008-09)