Mumbai, July 29: Reserve Bank governor Yaga Venugopal Reddy socked the financial sector with a double blow today by raising the repo rate and the cash reserve ratio (CRR) to 9 per cent each.
The surprise 50-basis-point hike takes the repo rate to an eight-year high. CRR has been increased by 25 basis points to a level that hasnt been seen since October 1999.
Reddy — whose term at the central bank ends in September unless he wins an extension — made what could be his final policy announcement memorable as he stuck doggedly to his resolve to fight inflation which has peaked to a 13-year high.
The announcement stunned the banks and the capital markets which had expected the central bank to either raise the repo rate or CRR by 25 basis points in its quarterly review of monetary policy.
The repo is the rate at which the RBI provides liquidity to banks; CRR is that percentage of deposits which commercial banks must park with the central bank.
The 25 basis points hike in CRR will drain close to Rs 9,000 crore from the system.
Although monetary policy does not influence the price of individual commodities like food items, the objective is to cool down aggregate demand till supply picks up, Reddy told reporters at a press conference after the policy announcement.
The Reserve Bank trimmed its economic growth forecast to 8 per cent from the earlier range of 8 to 8.5 per cent.
Reddy also said the central bank intended to wrestle inflation down to 7 per cent by March 31 next year. For the week ended July 12, inflation was running at 11.89 per cent — and threatens to become a major election stump issue.
Reddy stressed that if the central bank did not take firm measures now, it would feed into inflation expectations and disrupt the countrys growth.
There are some who believe that we should fight inflation with greater vigour, but then there could be more disruption. On the other hand, there are some who believe that we should go soft; but if you go soft, growth itself will be jeopardised. Therefore, we have to do a balancing act, he said.
Reddy said by raising the repo rate by 50 basis points and CRR by 25 basis points, the central bank was taking a nuanced way to cool inflationary expectations.
In an environment of limited supply elasticities in the short run, an adjustment of overall aggregate demand on an economy-wide basis is warranted to ensure that generalised instability does not develop and erode the hard-earned gains, the RBI said in its policy statement, thereby explaining that its objective was to control aggregate demand at a time when supply was not responding to a vault in demand.
The central bank said aggregate demand pressures existed in the economy and was exacerbated by the poor supply side response. While inflation expectations had risen because of pressures emanating from international commodity prices, this escalation had occurred in an environment of high growth in certain monetary and banking parameters which were riding higher than projections. Investment demand was also strong, the RBI noted.