Rajan unmoved by US Fed effect,prepares shield for tough days ahead

Interest rates to rise as RBI hikes rates; Sensex plunges by 382.93 points to 20,263.71; Rupee declines to 62.23/$

Written by ENS Economic Bureau | Mumbai | Published:September 21, 2013 3:12 am

Interest rates are set to rise across the banking system after the Reserve Bank of India on Friday unexpectedly hiked the benchmark repo rate to tackle “mounting” inflationary pressures and “preserve the internal value” of the rupee.

EMIs (equated monthly installments) on home,auto and personal loans are likely to go up with RBI Governor Raghuram Rajan opting for a hawkish stance in his first monetary policy review and raising the repo rate – the rate at which the RBI lends funds to banks — by 25 basis points to 7.50 per cent,the first hike in the benchmark rate in the last two years,to ward off rising inflation.

The markets reacted negatively to Rajan’s move with the BSE Sensex,which soared 684 points on Thursday,plunging by 382.93 points to 20,263.71. The rupee too declined by 0.74 per cent to 62.23 against the dollar.

However,Rajan rolled back some emergency measures put in place to support the ailing rupee after the US Fed indicated its plan to delay withdrawal of monetary stimulus plan earlier this week. The RBI reduced the marginal standing facility (MSF) rate by 75 bps to 9.50 per cent. It also reduced the minimum daily cash reserve balance that banks have to maintain to 95 per cent of the requirement.

“We believe that easing the exceptional liquidity measures was warranted given that the external environment has improved and given that the government and the RBI have used the time… to narrow the current account deficit and to ease its financing,” Rajan said.

Commenting on the RBI policy,Deputy Chairman of Planning Commission Montek Singh Ahluwalia said,“I think it is a quite balanced statement actually. He has done something which will ease liquidity and at the same time try to send the signal that the RBI is concerned about bringing inflation down. You need to give both those signals.”

SBI chairman Pratip Chaudhuri said banks would first raise the deposit rates and then they will calibrate the lending rate.

Anticipating a rate hike,SBI had increased the lending rate on auto and home loans by as much as 0.20 per cent on Thursday itself.

Rajan also announced the RBI’s intention to return to normal monetary operations where the repo rate will return to being the effective policy rate and liquidity conditions need not be as tight as they currently are. “The difference between the MSF and repo rate will be brought down to 100 basis points,” he said.

POLICY MEASURES

* Raises repo rate by 25 bps to 7.50%

* Reverse repo hiked to 6.50%

ROLL-BACK

* Lowers marginal standing facility rate by 75 bps to 9.50%

* Partially relaxes minimum daily cash balance requirement to 95% of deposits from 99%

GUIDANCE

* Timing,direction of further actions on exceptional measures will be contingent upon exchange market stability,and can be two-way

* Further actions need not be announced only on policy dates

* After steps taken to contain current account gap,focus now on internal determinants of rupee,primarily fiscal deficit and domestic inflation

* Growth could pick up in the second half of the year

* Despite good monsoon leading to some moderation in CPI inflation,no room for complacency

* In the absence of an appropriate policy response,WPI inflation will be higher than initially projected over the rest of the year

* Repo rate to resume its role as operational policy rate

“Banks would first raise the deposit rates and then they will calibrate the lending rate. Now the busy season has started so there is a huge credit demand”

Pratip Chaudhuri,Chairman,SBI

“The repo hike is a reflection of inflation. I expect that in the later part of this fiscal there can be a correction in rates.”

Keki Mistry,Vice Chairman and CEO,HDFC Ltd

“The policy signals the return to the repo rate as the key policy tool as well as RBI’s intention to cautiously unwind the exceptional measures”.

Chanda Kochhar,MD & CEO,ICICI Bank

“The RBI has admitted that industrial activity continues to remain sluggish… In such a scenario,a positive signal would have helped perk up sentiments”.

Naina Lal Kidwai,President,Ficci

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