Mumbai, Oct. 31: Banks will find their cost of borrowings going up after Reserve Bank governor Yaga Venugopal Reddy decided to nudge up the repo rate by 25 basis points to 7.25 per cent and leave all other policy rates, including the rate signalling reverse repo, unchanged.
The Reserve Bank’s decision was interpreted as a sign of caution and an indication that Reddy was loathe to trammel the growth momentum in the economy with a fourth rate rise this year.
While repo is the rate at which the central bank lends funds to the banking system, the reverse repo — the tool it uses to suck out funds — was unchanged at 6 per cent. The reverse repo rate serves as the signal for interest rate movements. The RBI had raised this short-term rate thrice this year, prompting banks to raise interest rates.
Industry reacted with caution to the policy statement. While Ficci said the move would raise the cost of capital and adversely affect industrial growth, both CII and Assocham said the move was “very balanced, forward looking and aimed at taming inflation without dampening economic growth”.
Ficci president Saroj Kumar Poddar said, “The announcement of a hike in the repo rate by 25 basis points, is bound to pinch small and medium enterprises.”
“The credit policy provides the right compass to take the economy forward, and the increase in the repo rate would effectively sound the note of caution on the liquidity front,” said CII president R. Seshasayee.
Adopting a hawkish tone that indicated a rate hike in the near future, RBI warned that it would be monitoring the economy closely to suss early signs of overheating against the background of excess aggregate demand.
“An overheating economy is one which is growing rapidly and its productive capacity cannot keep up with resulting demand pressures. Emergence of inflationary pressures is seen as the first indication of overheating,”it said.
The central bank, however, added that at the current juncture there is no conclusive evidence of overheating in the Indian economy. Though crude prices have eased in the recent past, thereby lowering the pressure on inflation, RBI continues to be cautious.
“Inflationary pressures, as exhibited in wholesale and consumer prices need continued special focus. Despite recent easing, oil prices at current levels may still contain some elements of a permanent component. Hence, the possible risks for inflation in the months ahead need to be viewed,” the RBI said even as it expressed the confidence that inflation will be reined in between 5 and 5.5 per cent this year.
The RBI revised the GDP growth forecast to 8 per cent from 7.5-8.0 per cent.
ECB rules relaxed
The mid-term review was also marked by some key relaxations.
The RBI said borrowers, currently eligible for accessing external commercial borrowings (ECBs), can avail of an additional amount of $250 million with average maturity of more than 10 years under the approval route, over and above the existing limit of $500 million under the automatic route, during a financial year.
With a view to providing greater flexibility to corporate houses in managing their liquidity and interest costs, prepayment of ECB was also upped to $300 million, as against the earlier limit of $200 million.
Sop for FIIs
Foreign institutional investors (FIIs) have been allowed to invest in securities issued by the central and state governments by an incremental amount of 5 per cent of total net issuance in the previous financial year. This would be over and above the current stipulation of investment up to $2 billion.
The existing limit of $2 billion will be enhanced in phases to $2.6 billion by December 31, 2006 and further to $3.2 billion by March 31, 2007.