Highlights of the policy
RBI Governor, Dr D V Subbarao announced the first quarterly review of monetary policy today. The measures taken were quite on the expected lines (Read our article on monetary policy expectations).
- Benchmark Repo rates hiked by 25 bps to 5.75% with immediate effect.
- Benchmark Reverse Repo rates hiked by 50 bps to 4.50% with immediate effect.
- The interest rate corridor between the Repo and Reverse Repo window reduced to 125 bps from 150 bps.
- CRR, SLR and Bank rate kept unchanged at 6%, 25% and 6%, respectively.
- Baseline inflation projection for March 2010 increased to 6% from 5.5%.
- Baseline estimate for GDP growth for 2010-11 revised to 8.5% from 8%.
- Bank deposit growth target of 18% maintained for FY2010-11; Bank deposit growth stood at 15.0% year-on-year as on July 2, 2010.
- Bank credit growth target of 20% maintained for FY2010-11; Bank credit growth stood at 22.3% year-on-year as on July 2, 2010.
- RBI to undertake mid-quarter policy reviews starting September 2010.
Impact of monetary policy
- As expected, RBI has raised the policy rates. This is the fourth rate hike since March this year raising the Repo by a total of 100 bps and Reverse Repo by 125 bps. Moving differently from earlier moves, the quantum of change in the policy rates; repo and reverse repo is different (What are policy rates?). The Liquidity Adjustment Facility (LAF) corridor has been shrunk to 125 bps, a change first time since November’2008.
What this means?
Short term interest rates, particularly, interbank repo market rates hover in between the LAF corridor in order to prevent arbitrage opportunities for the banks. Because of tight liquidity conditions, short term rates have been quite volatile. This measure is aimed at containing this volatility in the rates.
- Since end-May, banks have been borrwoing from RBI through its LAF Repo window. Out of four rate hikes since March, two were effected when there was ample liquidity in th system. But the last two have come at a time when the liquidity conditions have tightened. Thus interest cost of banks will go up. Assuming that banks will borrow about Rs 50,000 cr for the year as whole from Repo, the combined efect of the last two hikes will shave off about Rs 250 cr from banking sector’s profits.
- What would also hurt banks’s profitability is that deposit rates have also risen. Thus lending rates, in general will go up in order to protect net interest margin (NIM).
- Inflationary expectations have driven RBI to raise the rates. Policy stance of RBI has shifted to “to containing inflation and anchoring inflationary expectations”. RBI has noted that inflationary expectations have firmed up. Accordingly, RBI has also raised the projection for end-March 2011 to 6%. RBI has commented that it will continue to take actions to counter inflationary expectation.
- Though RBI has not hinted at further rate hikes, but its strong concern for inflation implies that good growth prospect along with continued high inflation will in make it imperative fro RBI to increase rates.