Policy rates hiked: Will banks raise lending rates?

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The expected has happened only the timing was unexpected. The Reserve Bank of India (RBI) has raised the reverse repo and repo rates by a quarter per cent.

RBI's 2-page press note on Friday evening announcing the rate hike has the word inflation writ large in every line. The central bank has pointed out that food prices, despite some moderation in the last few weeks remain at an elevated 16%; the consumer price indices have been rising in recent months.

But the most dramatic shift according to the RBI has been in the non-food manufacturing index. The inflation in this category has risen from -0.4% in November to 0.7% in December to 2.8% in January and 4.3% in February.

The second reason for the hike is the robust recovery numbers. Industrial output grew at 17.6% in December and at 16.7% in January. In addition a 39% rise in capital goods in December and a 56% rise in January show that investment activity has revived.

The RBI points out that the current reverse repo and repo rates are more in line with a crisis economy rather than a fast recovering economy. Given the strong growth, low policy rates can increase demand side pressure and worsen inflationary expectations, hence the move to hike rates.