The Telegraph
Since 1st March, 1999
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Caution on easy-money carnival
- Change of course with repo hike

Mumbai, Oct. 25: The Reserve Bank of India (RBI) today tweaked the reverse repo rate upwards by 25 basis points to 5.25 per cent and the repo rate by the same margin to 6.25 per cent even as it nudged up its growth forecast for the economy to 7-7.5 per cent from the earlier estimate of 7 per cent.

The reverse repo ' the rate at which the RBI borrows overnight from commercial banks ' has become the central bank's main policy tool since October 2004 because commercial lenders now have loads of cash. A higher repo will persuade banks to park more funds with the RBI rather than lend them out to companies.

The RBI has been deeply concerned about the runaway rise in bank credit and the quality of credit. It has asked banks to review their benchmark prime lending rates (BPLR) ' currently hovering around 10.25 to 11.25 per cent in public sector banks ' since many of them were lending money for as low as 3.35 per cent, making a mockery of the benchmark rate and raising serious questions about the transparency in loan pricing.

In its annual report for 2004-05, the RBI had noted with concern: “Sub-BPLR lending of the banking system (excluding exports, the bulk of which is at sub-BPLR) constituted over 65 per cent of outstanding advances above Rs 2 lakh.”

The hike in key short term rates comes in the wake of higher growth in money supply and rising prices, with the RBI admitting that inflation continues to be the biggest cause for worry as global oil prices are still not receding and are expected to be volatile in the coming months.

However, more than the rate hike, it was the hawkish tenor on inflation that the RBI sounded in its mid-term review of annual policy statement, which convinced observers that there would be another 25 basis point hike in the reverse repo rate come January when the apex bank undertakes the third quarter review of the annual policy.

The RBI, however, left the bank rate (through which it re-finances banks) and the cash reserve ratio (CRR) at 6 per cent and 5 per cent respectively. The bank rate has been pegged at 6 per cent since April 2003, its lowest level since May 1973.

The central bank also rationalised the rules governing banks’ exposure to the capital market.

Taking into account the recent trends in credit growth, the RBI has increased the provisioning requirement that banks will have to make for standard advances to 0.40 per cent from 0.25 per cent. The RBI pointed out that given the outlook for inflation primarily in the context of the oil economy in India, “It may be difficult to contain the inflation in the range of 5.0-5.5 per cent projected earlier without an appropriate policy response.”

It went on to add further that measures would be considered in a calibrated and prompt manner, in response to evolving circumstances with a view to stabilising inflationary expectations. Later addressing newspersons, RBI governor Y.V. Reddy said the hike in the reverse repo rate was a policy response to stabilise the inflationary expectations.

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