The Telegraph
Since 1st March, 1999
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Rate shield to block price punch

Mumbai, July 25: Yaga Venugopal Reddy, governor of the Reserve Bank of India (RBI), is known to deliver surprises.

But on Tuesday, the markets and bankers were proved right after betting that he would raise the reverse repo rate by 25 basis points to 6 per cent in a bid to snare inflation, which the central bank and the government want to hold between 5 and 5.5 per cent this fiscal.

The reverse repo determines the returns that banks will earn on their excess funds that they park with the central bank and has emerged as a key rate signaller for the financial market.

This is the third time this year that the RBI has raised the reverse repo ' and in tandem the repo rate, the rate at which banks borrow funds from the central bank, is now being raised to 7 per cent.

The reverse repo rate is now at its highest level in the past four years.

Although the 25 basis points hike each in reverse repo and the repo rate was in line with expectations, Reddy signalled that the interest rate tightening phase may not be over as yet as there are risks both globally and within the country.

The RBI however, left the cash reserve ratio (CRR) and the Bank Rate unchanged at 5 per cent and 6 per cent respectively.

In its first quarter review of monetary policy for 2006-07, the central bank warned that global and domestic factors were impinging on local inflation expectations. In April, it had warned of three key risks from global developments for emerging economies like India: potential escalation and volatility in international crude oil prices, a disorderly unwinding of global imbalances and hardening of international interest rates.

“Since then, the evolution of the global economy seems to indicate that each of these risks is materialising; in fact, these risks appear to have heightened in recent months,” the RBI warned.

Reddy later amplified these points and said while there were very strong growth impulses in the Indian economy, there were some inflationary pressures, among which the most well-known and intensely experienced are oil prices.

Even as these global risks remain, there are some “disturbing signs” on the home front. Internally, the Reserve Bank warned that money supply, deposit and credit growth were running well above the indicative projections, warranting caution by all concerned. According to RBI, there are demand pressures in the domestic economy alongside supply pressures such as high oil prices.

Here it pointed out that high credit growth, which exceeded growth in deposits, could exert upward pressure on prices when associated with supply shocks such as from oil.

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