Mumbai, April 28: The Reserve Bank (RBI) has signalled higher interest rates by raising the reverse repo rate a quarter of a percentage point to 5 per cent in a move prompted by its resolve to rein in oil-induced inflation.
Reverse repo rate is what RBI pays banks when it borrows from them over the short term to soak up funds that would have otherwise chased goods in the market and pushed up prices. The decision will come into effect from Friday, said central bank governor Y. V. Reddy.
The bank rate, at which banks price much of their loans, stays at a three-decade low of 6 per cent. Bankers say this will help keep long-term borrowing costs down for firms.
Some analysts were taken by surprise by the swiftness with which the RBI nudged up the reverse repo rate, given that this had been raised by 25 basis points in October ' when the last policy was unveiled. They had believed the hike would come after June, by when the pattern of monsoon will be evident.
'It's a loud and clear indication, but not unexpected. Interest rates will go up,' said Dipak Gupta executive director of Kotak Mahindra Bank. Y. M. Deosthalee, chief financial officer of Larsen & Toubro, agreed. 'The policy sends out a sharp signal towards a turn in the rate cycle.'
Recognising that supply factors, particularly oil, will continue to dominate prices, the policy flashes a warning on the excess cash swirling about in the system.
'This is a calibrated response to maintain the growth momentum of the economy in a situation of enough liquidity and rising inflation,' Deosthalee added.
In its annual policy statement, the central bank forecast growth in the current financial year at 7 per cent and annual inflation at 5-5.5 per cent by the end of March 2006 ' lower than market expectations of 5.5-6 per cent. 'Inflation, on a point-to-point basis, may be around 5-5.5 per cent. It could change with oil prices,' the RBI said.
Referring to the risks from oil, Reddy said of the 41 per cent increase in the country's oil basket last year, only 17.5 per cent has been absorbed. High crude prices have been worrying the central bank and the government, which has kept fuel rates unchanged for six months.
'If oil prices continue to firm up at the pace seen this year, markets could see a major impact. The pace of economic activity will slacken, corporate earnings will fall and external imbalances will sharpen,' the policy said.
The concern over inflation has come into sharp focus but bankers feel there is no immediate pressure to hike interest rates. ICICI Bank chief executive K. V. Kamath said he saw no increase in the cost of funds now.
'The RBI is bullish on growth. The increase in reverse repo rate shows its concern over inflation, State Bank chairman A. K. Purwar said.
The hike was the second in the space of six months. The rate was jacked up by 25 basis points from a four-decade low of 4.5 per cent last October, the first rise in four years.