Summary
'CPI inflation will exceed 9% in the three months ending March 31; CAD to decline to below 2.5% of GDP'.
The Reserve Bank of India raised interest rates by 25 basis points or 0.25 percentage points to suppress flaring of inflation trends but assured investors, borrowers and lenders that it does not envisage future increases.
Governor Raghuram Rajan also noted that he does not expect the growth rate of the economy to improve beyond 5.5 per cent next year too unless export performance improves. Rajan described the rate hike as one "that needs to be fought against inflation".
While most sections of industry said they were disappointed with the rise, claiming it will raise the cost of borrowing from banks, Rajan was emphatic the rise will not have a direct impact on them.
The repurchase (repo) rate, the rate at which RBI lends money to banks, is now 8 per cent from 7.75 per cent. The cash reserve ratio, or part of the incremental deposits banks keep with the central bank, is unchanged at 4 per cent.
The governor said the "gravest risk to the value of the rupee is from consumer price index (CPI) inflation which remains elevated at close to double digits".
Rajan told reporters there was no either or situation between growth and inflation. "Even if we cut rates, banks won't as inflation is still high. We have to get away from the fact that there is a magic wand. The notion about inflation being irrelevant has to be revisited."
He explained that higher levels of inflation cut household budgets and "constrict the purchasing power of consumers. This, in turn, discourages investment and weakens growth".
This is the second time the RBI has raised interest rates after Rajan became governor. He had announced a pause in December saying he would wait for more data before deciding to extend the pause or resume raising rates.
The RBI, he said, has also accepted a report by a committee chaired by Deputy Governor Urjit Patel which suggests holding rate meetings every two months instead of every six weeks now.
India is the second country after Brazil to raise interest rates in recent weeks. Rajan said the primary focus of the RBI action is not the markets but the Indian consumer. "We need to create the environment for a strong recovery. Inflation is part of that environment. The government is also creating conditions for growth. We will work jointly."
Lief Eskesen and Prithviraj Srinivas, economists at HSBC, said the RBI ended up adhering strictly to its forward guidance, which was a very welcome decision. Rohini Malkani of Citibank said the repo hike on Tuesday was a bit of a surprise but the decision was in line with her view of a 25 bps hike in the fourth quarter of fiscal 2014.
"Going forward, we expect the rates are likely to stay higher through 2014," she said. Industry bodies CII and Ficci said they hoped the RBI will focus on cutting the cost of lending in subsequent monetary reviews.
The Indian currency, bonds and stock markets were surprised by the hike and dipped initially. The rupee that had slipped way below 63 to a dollar, recovered by 51 paise and so did stock markets. The BSE Sensex closed just 24 points down after initially falling 215 points.
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