Soaring prices prompt India’s central bank to hike key rates (Roundup)

MUMBAI - With inflation soaring to double-digits and factory output growing in spurts, India’s central bank Tuesday hiked its short-term lending and borrowing rates by 25 basis points that could make commercial, housing and auto loans dearer, while also seeking not to undermine the overall growth process.

Reserve Bank of India (RBI) Governor Duvvuri Subbarao hiked the repurchase or repo rate to 6.5 percent from 6.25 percent and reverse repo rate to 5.5 percent from 5.25 percent. Other rates like cash reserve ratio and statutory liquidity ratio remained unaltered.

The key policy rates were tinkered for the seventh time since January last year as part of the third-quarterly review of the central bank’s monetary policy by the governor at the headquarters on Mint Road in downtown Mumbai.

The repo rate, often referred to as the short term lending rate, is the interest charged by the central bank on borrowings by commercial banks. A hike in the rates makes cost of borrowing costlier for the commercial banks.

The reverse repo rate, referred to as short term borrowing rate, is the rate at which the central bank borrows money from commercial banks. A hike in this rate makes it more lucrative for banks to park funds with the RBI.

The cash reserve ratio and statutory liquidity ratio determines the amounts banks have to retain in liquid assets, gold and government bonds against deposits, and together form a part of traditional instruments that help in checking liquidity in the system.

The central bank also revised upward its inflation forecast sharply to 7 percent by the end of this fiscal, from 5.5 percent earlier, while the projection on growth has been retained at 8.5 percent with an upward bias.

“There have been some transitory supply shocks as reflected in the sharp increase in vegetable prices. In addition, petroleum and aviation turbine fuel prices were raised in January which will add 9 basis points to wholesale price inflation,” Subbarao said.

“With the risks to growth in 2010-11 being mainly on the upside, the baseline projection of real gross domestic product (GDP) growth is retained at 8.5 percent as set out in the second quarter review of monetary policy of July 2010, but with an upside bias.”

The governor said that the policy actions Tuesday will rein in the rising inflationary expectations, which may aggravate due to transitory nature of food prices, but yet be moderate enough not to disrupt growth.

The central bank also warned the federal government on its fiscal stand. “Any slippage in the fiscal consolidation process at this stage may render the process of inflation management even harder,” the bank said.

Although most industry associations and experts said the monetary policy changes Tuesday were on expected lines, the 30-share sensitive index of the Bombay Stock Exchange fell 0.95 percent, while S&P CNX Nifty of the National Stock Exchange declined 0.97 percent.

Finance Minister Pranab Mukherjee also said the steps were in line with the government’s thinking. The Reserve Bank has taken appropriate step to control inflation, and at the same time not to compromise the growth process,” Mukherjee told reporters in New Delhi.

The RBI acted with the measures mainly to tame prices, which had seen India’s annual food inflation shoot up to a 52-week high of 18.32 percent for the week ended Dec 25, before falling slightly to 15.52 percent for the week ended Jan 8.

Loans for automobiles, homes and corporate sector could go up as banks will look to pass on the interest burden to consumers. Leading bankers have already forecast a hike in the lending rates in the near term, taking into account a hike in key rates.

Industry, which saw its factory output dip to an 18-month low in November, was already worried since the annual wholesale price inflation in non-food articles that primarily reflects the cost of raw materials was ruling at 23.07 percent for week ended Jan 8.

“We are concerned the RBI is setting the stage for a series of rate hikes that will have a negative impact on the investment momentum going forward,” said Chandrajit Banerjee, director general of the Confederation of Indian Industry (CII).

“Persistent shortage of liquidity in the banking system has already raised expectations that interest rates will harden considerably in the coming year,” Banerjee added. The other chambers also hoped the interest rates will be kept stable in the medium term.