RBI’s Rajan plays it tough, hikes repo rate by 25 bps to 7.5%

The Reserve Bank of India (RBI) has decided to tighten interest rates contrary to popular expectations of an easier monetary regime under new governor Raghuram Rajan.

The RBI today announced an increase in the key policy repo rate, under which it buys government securities from banks under the liquidity adjustment facility (LAF), by 25 basis points to 7.5 per cent from 7.25 per cent with immediate effect.

Consequently, the reverse repo rate under the LAF stands adjusted to 6.5 per cent and the Bank Rate stands reduced to 9.5 per cent.

With these changes, the MSF rate and the Bank Rate are recalibrated to 200 basis points above the repo rate.

RBI, however, reduced the marginal standing facility (MSF) rate by 75 basis points to 9.5 per cent from 10.25 per cent with immediate effect. This has been done on the basis of an assessment of the current and evolving macroeconomic situation, RBI said in its monetary policy statement released today.

RBI also reduced the minimum daily maintenance of the cash reserve ratio (CRR) from 99 per cent to 95 per cent effective the fortnight beginning 21 September 2013, while keeping the overall CRR requirement unchanged at 4.0 per cent.

RBI expects the inflationary pressures to continue in the backdrop of high international prices of fuel and other commodities and a falling rupee in the absence of an appropriate policy response.

Since the first quarter review in July, RBI noted that economic growth has slowed in India and in several emerging economies buffeted by heightened financial market turbulence on the prospect of tapering of quantitative easing (QE) in the US.

However, a weak recovery has been taking hold in advanced economies, with growth picking up in Japan and the UK and the euro area exiting
recession.

While the US Federal Reserve's decision to hold off tapering of its monetary expansion has buoyed financial markets, RBI said, a tapering is inevitable over the longer term.

On the domestic front, RBI said, growth has weakened with continuing sluggishness in industrial activity and the service sector. The pace of infrastructure project completion is subdued and new project starts remain muted.

Consumption, while relatively firm so far, is starting to weaken even in rural areas, with durable goods consumption hit hard. Consequently, growth is trailing below potential and the output gap is widening.

RBI expects some pick-up on account of the brightening prospects for agriculture due to kharif output and the upturn in exports. Also, as infrastructure investments are expedited, and as projects cleared by the Cabinet Committee on Investment come on stream, growth could pick up in the second half of the year.