The Telegraph
Since 1st March, 1999
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Repo sword to fence prices

Mumbai, June 8: In a surprise move that could push up interest rates on housing loans and bank deposits, the Reserve Bank of India (RBI) today hiked the reverse repo and repo rates by 25 basis points to 5.75 per cent and 6.75 per cent respectively to rein in inflation which is widely expected to spurt after the fuel price increases this week.

While the reverse repo is the instrument through which the central bank mops up excess liquidity from the banking system, the repo helps it inject cash into the system. A rise in the reverse repo rate would lead to cost of funds for the banking system inching up, thereby leading them to re-price their loans and deposit rates.

The RBI decision, and more particularly, its timing, stupefied many in the banking industry and came on a day when the BSE sensex shed 461 points. Bankers had expected the central bank to raise these key rates by 25 basis points each in its next review of monetary policy on July 25.

The rate hikes by the Reserve Bank came on the very day that central bankers in Europe and South Korea also raised their key policy rates in a seemingly orchestrated move to tame inflation.

Bankers in Mumbai said there could be two major reasons for the apex bank to raise interest rates ahead of its review next month. The first relates to inflation. Figures released last week showed that the inflation rate rose to 4.74 per cent for the week ended May 20 from 4.32 per cent in the previous week.

Analysts feel that inflation numbers that will be released tomorrow could show a further jump and that they may inch towards the 5 per cent mark.

This is not inclusive of the impact that will come from the recent decision of the government to raise petrol and diesel prices. “It is expected that tomorrow's inflation numbers will be higher. Moreover, with oil prices being hiked, it could add another 40-42 basis points. Therefore, the RBI raised interest rates to check inflation,” says Ajay Mahajan, president of Yes Bank.

The second reason being cited relates to central banks around the world raising interest rates to contain inflation. While Ben Bernanke, chairman of US Federal Reserve, recently gave strong signals that rates may be hiked in the next meeting later this month, the European Central Bank today hiked interest rates by 25 basis points to 2.75 per cent. This is not to include the central banks of Thailand and Turkey which have also chosen a similar path. “The RBI is only following the global cues,” says another banker.

With both these key short-term rates being raised, interest rate on home loans and deposits are set to look up even as there is a strong possibility that the RBI may again raise rates in its July review. Bankers, however, said while a hike in deposit rates may come quickly, home loans will turn dearer albeit with a lag.

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