RBI hints at future hikes on heightened inflation worries

Rex Mathew
31 January 2007

Though the repo rate hike was limited to 25 basis points, the RBI's policy statement is very hawkish on inflation and states in no uncertain terms that further rate hikes may be required in future.

The Reserve Bank of India has hiked the repo rate by 25 basis points to 7.5 per cent, but left the reverse repo rate unchanged at 6 per cent in the latest quarterly review of its monetary policy review. Repo rate is the interest rate at which the RBI lends money and reverse repo rate is the rate at which the central bank borrows money from the market. The bank rate and cash reserve ratio (CRR) have been left unchanged at 6 per cent and 5.5 per cent respectively.

While the 25-basis point hike in repo rate was almost certain, stock and money markets were expecting at least a 25 basis increase in the reverse repo rate as well. As liquidity conditions have been tight in recent months, the RBI has been infusing funds through its liquidity adjustment facility (LAF). This scenario makes the repo rate the key operating rate and by hiking it the RBI is sending a clear message.

Stock market recovered sharply and bond market rallied after the policy announcement. However, traders and investors have shed most of their earlier excitement after a reading of the detailed policy statement by RBI

The central bank's policy statement is even more cautious than earlier on inflationary risks which persist despite the monetary and fiscal measures. Though the central bank has maintained its inflation target range at 5 per cent to 5.5 per cent, there are many over-cautious references and statements in the policy statement. The latest statement also repeats the risks of overheating in the economy, though the RBI admits such risks could be transitional in nature.