RBI hikes policy rates to fight inflation

With the latest round of rate hike, the repo rate is now 6% and reverse repo rate 5%, shrinking the gap between the two rates or the rate corridor to 1 percentage point.

The Reserve Bank of India (RBI) on Thursday hiked its repo rate or the rate at which it lends to commercial banks by 0.25 % and reverse repo rate or the rate at which it drains liquidity from the banking system by 0.50 % in its first-ever mid-quarter review to fight inflationary pressures.

With the latest round of rate hike, the repo rate is now 6% and reverse repo rate 5%, shrinking the gap between the two rates or the rate corridor to 1 percentage point.

Analysts and economists said the current rate of inflation and pick up in industrial production influenced the central bank’s policy decision.

The industrial output expanded by 13.8 % in July, more than twice the pace in the previous month.

Bankers, however, were hoping that RBI will go soft on the rate front.

Nine out of the 12 bank chiefs who participated in a rent Mint snap poll had said they did not expect the central bank to increase rates.

The wholesale-price based inflation dropped to 9.8% in July after staying in double digits for five consecutive months. It further fell to 8.5 % in August after the government changed the base year to 2004-05 from 1993-94.

However, the 8.5% inflation figure was arrived at after changing the base year. Following the old method, the August inflation would have been 9.5%.

The central bank’s move, which came as expected by economists and analysts, is likely to prompt banks to hike their base rates by at least 25 basis points in the near future, bankers said.

Base rate replaced the benchmark prime lending rate since 1 July. This is the fifth time the central bank is increasing its policy rates this year.

So far in 2010, the RBI has hiked its overnight lending rate or the repo rate by 125 basis points and the reverse repo rate by 175 basis points.

One basis point is one hundredth of a percentage point. “There is a strong possibility that our base rate going up by 0.25 %. This is a signal that cost of funds and lending rates will go up. Banks will have to take a view on this now,” State-run Bank of Maharashtra, chairman and managing director, Allen C A Pereira said.

Key rates	July 3rd 2010	July 27th 2010	Sep- 16 2010
CRR	6	6	6
Repo Rate	5.5	5.75	6
Reverse Repo	4	4.5	5
Bank Rate	6	6	6