RBI hikes short-term rates but CRR unchanged

The central bank raised interest rates more forcefully than expected on Tuesday in the face of inflation that has held stubbornly above 10 percent for the past five months. The Reserve Bank of India said it would continue to normalise policy in line with the growth and inflation rate in the economy.

In the recent past, it had said repeatedly that it would follow a “calibrated” exit from loose monetary policy, which markets had taken to mean 25 basis point rate hikes at each quarterly review. “The dominant concern that has shaped the monetary policy stance in this review is high inflation,” the central bank said.

“With growth taking firm hold, the balance of policy stance has to shift decisively to containing inflation and anchoring inflationary expectations,” it said. The central bank, which reviews monetary policy on a quarterly basis but has twice this year surprised investors with off-cycle rates, also said it would begin undertaking mid-quarter reviews.

The RBI lifted the repo rate, at which it lends to banks, by 25 basis points to 5.75 percent, which was in line with expectations, but raised the reverse repo rate, at which it absorbs excess cash from the system, by a steeper than expected 50 basis points to 4.50 percent.

India’s benchmark 10-year federal bond yields eased briefly immediately after the policy announcement by one basis point while shares gained a tad after the central bank raised its key policy rates. As expected, the central bank left the cash reserve ratio (CRR) unchanged at 6 percent.

Inflation in India emerged last year in the wake of a poor monsoon that drove up food prices but has spread broadly throughout the economy, spawning protests against a government whose voter base is predominantly poor and rural. New Delhi’s decision to increase fuel prices is expected to add nearly a percentage point to wholesale price index (WPI) inflation starting in July and led the opposition to call a one-day nationwide strike early this month.

The government is counting on normal summer monsoon rains to results in better crop yields and ease pressure on food prices, and has said inflation should decline to 6 percent by December, a figure private economists put closer to 8 percent.