The Reserve Bank of India (RBI) has hiked the repo and reverse repo rate by 25 basis points (100 bps=1%). The new repo and reverse repo rate is 5% and 3.5%, respectively. The hike comes into effect immediately.
The rate at which the central bank lends money to commercial banks is called the repo rate while the reverse repo is the rate at which RBI borrows money from banks.
The central bank promises to take further action as and when warranted. "We continue to monitor macro conditions and the price situation. The steps undertaken will help anchor inflationary expectations and contain inflation," RBI said in a statement.
On inflation: Food prices are showing signs of moderation, but continue to be elevated, it said. "Consumer price inflation has accentuated further." Food price index rose 16.3% in the year to March 6, lower than the annual rise of 17.81% in the previous week, continuing a downward trend for the second straight week.
The monthly wholesale price inflation stood at 9.89% in February. RBI stated that there was a risk that WPI inflation may cross the double-digit mark in March.
The price rise in fuel items is also of 'particular concern' to the apex bank.
On economic recovery: RBI sees the economic recovery consolidating. "We didn't hike rates in the January policy to let the recovery take full hold. The recent industrial productivity data suggests a revival in private demand, which may add to inflationary pressure.
It shows that the uptrend is being maintained," it explained.
It attributes this positive economic trend predominantly to domestic factors. "The economic recovery is gaining momentum on the rise in bank credit."
Allaying fears that the rate hike would hit credit supply, RBI said credit expansion to sustain recovery will not be affected. "The liquidity in the banking system remains adequate."
What do policymakers say? The Reserve Bank is hiking rates in small doses as it does not want to hurt growth, Kaushik Basu, Economic Advisor to the Finance Ministry, told Reuters. "RBI rate hike is aimed at curbing and significantly anchoring inflationary expectations. Inflation was seen spilling over to manufacturing. The real economy is strong, so a rate hike will not hurt industrial output. This is a signal that though growth is an imperative, inflation is a concern."
When asked if there could be further action by the central bank in April, Basu said, "Going forward, I am not ruling out another rate hike, but that depends on the data relating to the prevailing inflationary situation."
Pronab Sen, Chief Statistician of India, said the rate hike is consistent with the cash reserve ratio hike in the January policy. According to him, inflation is alarming as non-farm group has gone up and there is a fear of food inflation spilling over to the real economy. He feels it is difficult to say if price situation will ease soon.