The RBI once again has gone for what it calls pre-emptive action. It has chosen to hike the reverse repo and the repo rates by 25 basis points because of the imminent dangers to price stability, and also because all growth indicators are running well above projections.

The RBI in its review says that both domestic and global factors are delicately balanced in terms of growth vis-a vis price stability, with a tilt towards the possibility of identified downside risk materialising in the near term being more likely than before.

RBI has left CRR, and the Bank Rate unchanged.
It's GDP growth forecast for FY07 is unchanged at 7.5-8 per cent.

The inflation target for FY07 is unchanged at 5.0-5.5 per cent.

Highlights of the rate hike:

• Reverse repo rate increased to 6.0 per cent and repo rate to 7.0 per cent.
• Bank rate and cash reserve ratio kept unchanged.
• GDP growth projection for 2006-07 retained at 7.5-8.0 per cent.
• Containing inflation within 5.0-5.5 per cent for 2006-07 warrants appropriate priority in policy responses.
• Money supply, deposit and credit growth above the indicative projections, warranting caution.
• Appropriate liquidity to be maintained to meet legitimate credit requirements, consistent with price and financial stability.
• Barring the emergence of any adverse and unexpected developments in various sectors of the economy and keeping in view the current assessment of the economy including the outlook for inflation, the overall stance of monetary policy in the period ahead will be:
  • To ensure a monetary and interest rate environment that enables continuation of the growth momentum while emphasising price stability with a view to anchoring inflation expectations.
  • To reinforce the focus on credit quality and financial market conditions to support export and investment demand in the economy for maintaining macroeconomic and, in particular, financial stability.
  • To consider measures as appropriate to the evolving global and domestic circumstances impinging on inflation expectations and the growth momentum.
• M3 growth projected At 15 per cent
• GDP growth of agriculture assumed at 3 per cent
• Companies sales growth and PAT improved in FY07 v/s FY06
• Expectations for overall business situation in Q2 FY07 are better than Q1 FY07
• Non food credit up 2.6 per cent at Rs37,749 crore in July v/s 1.8 per cent at Rs19,948 crore a year ago
• Non food credit up 32.9 per cent at Rs 3,71,993 crore v/s a year ago
• FY07 farm credit growth maintained at 3 per cent
• Stance is to focus on credit quality
• Retail lending increased by 74 per cent YoY
• Home loan growth at 115.5 per cent YoY
• Loans to commercial real estate rose by 101.3 per cent
• Loans to industry increased by 26 per cent YoY
• Bank lending to agriculture increased by 35 per cent YoY
• Banks reducing own investment portfolio to meet demand for credit
• M3 growth at 18.8 per cent higher by 13.8 per cent a year ago, higher than RBI projections
• Fuel prices constitute a major risk to headline inflation
  
• Continue liquidity management via OMO, LAF, MSS, CRR
• Global risks noted in April policy heightened
• Apr-Jun M3, deposit, credit growth above estimates
• Rise in M3, deposit, credit growth warrant caution
• Banks must focus on retail deposit mobilisation
• Current a/c deficit manageable in FY07
• Non-oil imports slackened; export growth robust
• Pass through of global oil to be higher than expected

Reactions:
The RBI has hiked the reverse repo and repo rate by 25 bps each. However, it has left CRR, bank rate, inflation target and GDP target unchanged at 5 per cent, 6 per cent, 5-5.5 per cent and 7.5-8 per cent respectively, reports CNBC-TV18.

In response to the latest credit policy news, Ajay Mahajan of Yes Bank says that the rupee is likely to strengthen further to 46.75/USD. According to him the policy suggests that the RBI will be pre-emptive. Also he says that bond markets will view the credit policy in a positive light.

Saumitra Chaudhary, member of the prime minister's Econmic Advisory Council says that a further hike will depend on the RBI's assessment. According to him, high interest rates will not impact growth rate.

According to Kalpana Morparia, joint MD of ICICI Bank the RBI rate hike was largely expected. She expects further sub-PLR and PLR hikes going forward. She believes that the Credit policy hike will have little impact on credit off take. Also, she sees retail loan growth at around 25 per cent in FY07.

Kotak MF says that the RBI statement is hawkish, and inflation can increase above the RBI's band.

Not surprised by rate hikes: FM
Finance minister P Chidambaram says that the rate hikes by the RBI does not surprise him. He believes that the entire exercise is due to robust economic conditions and the idea is to contain inflation.

Chidambaram doesn't believe that the economy will slow down on account of high interest rates. Rather, the demand is high with good credit offtake. Productive sectors of the economy, he adds, will not be denied credit.

He thinks that the RBI has recognised short-term rates and the government agrees with the RBI's assessment. On Inflation, he says, it is likely to be contained in short term.