RBI hikes repo rates to curb inflation

In a surprise move, the Reserve Bank of India hiked its main policy rates by 50 basis points today in its first quarter review of its monetary policy.
Consequently, the repo rate is now at 8 per cent while the reverse repo rate is at 7 per cent. The marginal standing facility (which is at 100 bps above the repo rate) will be at 9 per cent. The rate hikes are the eleventh successive hike since March 2010.
The market had expected a 25 bps hike in this quarter because of inflationary conditions. However, bankers had appealed to the RBI last week to hold its hiking cycle because of a slight slack in credit growth and lower industrial output in May. The RBI didn't oblige.
Inflationary pressures strong
 “Notwithstanding signs of moderation, inflationary pressures are clearly very strong... inflation continues to be the dominant macroeconomic concern. On the basis of this assessment, it has been decided to increase policy repo rate by 50 basis points from 7.5 to 8 per cent with immediate effect,” the RBI Governor, Dr D. Subbarao, said while announcing the quarterly review of the monetary policy.
The RBI’s unexpected decision led to a sharp decline of over 300 points in the BSE Sensex. The 30-share Sensex fell to 18,570 after announcement of the policy, although it had opened in positive terrain.
RBI Governor Dr D Subbarao explaining the monetary policy stance, said the policy decision had been informed by two broad considerations.  First, demand pressures have remained strong.  Actual inflation so far has been even higher than expected. In particular, non-food manufactured product inflation has been significantly higher than the average rate of four per cent over the last six years. Crude oil prices remain volatile and are a major risk factor. The recent increase in domestic administered fuel prices and the minimum support price for certain food items will also keep inflation under pressure.
The second consideration that shaped the policy decision is that there are signs that growth is beginning to moderate, particularly in respect of some interest rate sensitive sectors. However, there is no evidence, as yet, of a sharp or broad-based slowdown. Several indicators such as exports and imports, indirect tax collections, corporate sales and earnings and demand for bank credit suggest that demand is moderating, but only gradually.
Although the impact of past monetary policy actions is still getting transmitted, considering the overall growth-inflation scenario, the RBI determined that it is necessary to persevere with the anti-inflationary stance.
 
The three broad contours of the monetary policy stance according to Dr Subbarao were:
To  maintain an interest rate environment that moderates inflation and anchors inflation expectations.
To manage the risk of growth falling significantly below trend
Finally, to manage liquidity to ensure that monetary transmission remains effective, without exerting undue stress on the financial system.
The expected outcomes of today’s policy actions are the following:
·         First, the cumulative impact of past actions on demand will be reinforced;
·         second, the credibility of the commitment of monetary policy to controlling inflation, and thereby to keeping medium-term expectations anchored, will be maintained.
Third, the policy actions will reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required.