The Reserve Bank of India?s decision to hike its reverse repo and repo rates by 25 basis points was widely expected by the markets, which had priced in the increase. As a result, bond yields hardly moved and there was no impact on either the foreign exchange or the stock market. There are plenty of reasons for the rate hike. Inflationary expectations are high, primarily because of the continuing rise in crude oil prices. International crude oil prices have come down from their peaks, but they remain well above $70 a barrel. Under the circumstances, the government may soon be forced to allow another round of increases in fuel prices. As the RBI has pointed out, food prices too are a worry, especially as these have hardened in the international markets as well. But perhaps the biggest concern that the RBI has is the steep fall in the value of the rupee against the US dollar in recent weeks. True, the real effective exchange rate of the rupee shows that the rupee is still overvalued, albeit marginally. But oil is priced in dollars and depreciation pushes up the price of oil in rupee terms. A continuing slide in the value of the rupee therefore could push up inflation. International factors also need to be taken into account, especially the fact that the US federal reserve, the European and the Japanese central banks have all hiked their policy rates by 25 basis points each recently.

The outflow of foreign institutional investors? money from the stock markets is another factor that puts additional pressure on the rupee. In the circumstances, the RBI had little option but to raise interest rates. On the demand side, too, there are signs of overheating. As the RBI has pointed out, on a comparable basis, the non-food credit of scheduled commercial banks has increased by Rs 37,749 crore up to July 7, compared to Rs 19,948 crore in the corresponding period a year ago. In particular, retail lending and loans to commercial real estate have grown by leaps and bounds. Taken together with strong industrial growth, robust business confidence and abundant liquidity, this was the right time to hike rates. Interestingly, the RBI has also pointed out that ?monetary policy may not be unidirectional for a prolonged period, recognizing that the pace of changes in the global and financial environment is far more rapid now than ever before?. That is essentially the same message as that emanating from the US federal reserve. Nevertheless, so far as the domestic economy is concerned, there are few signs of a slowdown and it is very likely that there will be further tightening ahead.