The Reserve Bank of India raised interest rates Monday to strengthen the rupee against currencies such as the dollar and the euro. In the process it,however,raised the possibility of banks increasing lending and deposit rates.
The measures were announced after meetings between Finance Minister P Chidambaram and Prime Minister Manmohan Singh,followed by a meeting between Chidambaram and RBI Governor D Subbarao,who made an unscheduled dash to New Delhi.
The RBI pushed up the rate at which it lends money to banks by 200 basis points to 10.25 per cent. The marginal standing facility,which is the rate at which banks borrow additional funds from the RBI,will now be at 10.25 per cent.
To make these measures bite,the RBI also limited the sum banks can borrow at the softer rate of 7.25 per cent to Rs 75,000 crore per day with effect from Wednesday.
The Rupee has depreciated markedly in the last six weeks. Countries with large current account deficits,such as India,have been particularly affected despite their relatively promising economic fundamentals. Against this backdrop,and the need to restore stability to the foreign exchange market the measures were announced,a RBI statement said.
Subbarao has attempted to walk the tightrope between holding the rupees value and the risk of banks raising their base rates as money becomes costlier.
Jayesh Mehta,MD and country treasurer,Bank of America,said the RBI is tightening the money market. Holding on to any overseas financial assets including the dollar is now more expensive which can encourage a switch to rupees, he said.
The rupee has declined by 9.3 per cent against the dollar since the beginning of the year,making it the worst performer among all Asian currencies. It had dipped to a record low of 61.21 to the dollar on July 8. It closed at 59.89 Monday.