RBI raises repo, reverse repo rates to tame inflation

ECONOMIC TIMES
3 Nov, 2010
MUMBAI: Reserve Bank of India (RBI) governor Duvvuri Subbarao raised interest rates for the sixth time this year, probably the last in this cycle, to temper price increases that were threatening its credibility built assiduously in the last decade.


Home loans would turn more expensive as banks are forced to end `teaser rates’ and due to a cap on ratio of loan to value of homes, but that could slow the rate of price rises, helping buyers.

The economic growth forecast is retained at 8.5%, and the inflation target remains the same although it is cut 50 basis points to 5.5% to factor in the new-series Wholesale Price Index. A basis point is 0.01 percentage point.
But one unknown factor—the impact of yet another quantitative easing, or printing of more money, in the US to revive its economy—may throw all these forecasts to the winds if commodity prices surge and inflows make the macro economy unmanageable.

RBI raised the repo rate, the rate at which it lends to banks, by 25 basis points to 6.25% and the reverse repo rate by a similar margin to 5.25%. ``When the economy is growing close to trend, the risks of structural food inflation spilling over into prices of other commodities are significant and that could potentially offset the recent moderation,” Mr Subbarao said in his half-yearly monetary policy review. “RBI believes that the likelihood of further rate actions in the immediate future is relatively low.”

Inflation remains above 8%, contrary to the 5-5.5% average in the first decade of the millennium, since monetary policymakers ensured that prices were stable to take India to the global league, where 3% is tolerable.

“This record is an important foundation for the credibility of monetary policy and, more generally, the broader inflation management framework,” said Mr Subbarao.

The central bank has been measured in raising policy rates as it waited to see the establishment of growth momentum after the slowdown. It drew some criticism for falling behind the curve in maintaining price stability.

``This tightening may have a small negative impact on the growth rate, but I expect such an effect to be only a short-run one,” finance minister Pranab Mukherjee said in a statement. ``Today is not such an easy time. The signals from the economy have been mixed.”
Australia joined India in raising interest rates on Tuesday as it attempted to nip inflation in the bud, with rising demand for raw materials from China and investors buying real assets to protect against price rise.

Fearing that some of the liquidity generated out of capital inflows will chase real estate assets, the central bank has made institutional loans of over Rs 75 lakh more expensive for lenders by increasing the capital requirement on such loans.

“In the past, foreign banks have come in with teaser rates and have booked huge losses on their mortgage portfolios,” said Deepak Parekh, chairman at the largest mortgage lender, Housing Development Finance Corp. ``The banks have Rs 30,000-40,000 crore of such loans, we have to see how much capital they set aside.” Speaking to newspersons after the policy, OP Bhatt, chairman of the country’s largest bank, said what SBI was offering was a special rate scheme and could not be termed as `teaser’ rates.

“You must ask RBI the definition of teaser loan schemes... they don’t have any definition” said Mr Bhatt. “The increase in risk weight for residential housing loans of Rs 75 lakh and above from 100% to 125% could see some increase in interest rates on large-value housing loans. The increase in asset provisioning for teaser home loans from 0.4-2% could affect bank profitability as banks will have to make provisions on this account, about Rs 350-370 crore for SBI.” Mr Subbarao said there is no comfort level for the central bank in terms of capital inflows. Yet, he said, RBI will allow flows to finance current account deficit in the short run.

“The current account deficit had widened in the first quarter of 2010-11. If the current trend persists, the current account as a percentage of GDP for the whole year will be significantly higher than it was last year. It is generally perceived that a current account deficit above 3% of GDP is difficult to sustain over the medium term. The challenge, therefore, is to rein in the deficit in the medium term and finance it in the short term while ensuring that capital flows are not far out of line with the economy’s absorption capacity.”