RBI raises repo, reverse repo: What will happen on July 27?

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In an unexpected move the Reserve Bank of India (RBI) raised the repo and reverse repo rates by 25 basis points late Friday evening, effective immediately.

Its main lending rate, or the repo rate has been hiked from 5.25% to 5.50% and the reverse repo rate, at which it absorbs excess cash from the banking system, has been increased from 3.75% to 4%.

Though the hikes are broadly in line with street expectation, what has come is a surprise is the timing. Market veterans had been expecting the hike in rates in the Reserve Bank's Monetary Policy, which is scheduled to be reviewed on July 27.

Timing of the Action

Commenting on the bank's rationale behind the timing of the action, a statement released by the RBI stated that this mid-cycle policy action has been warranted by the evolving macroeconomic situation. "Even as data for real GDP growth and WPI inflation became available by mid-June 2010, it was considered inadvisable to raise the policy rates as the financial system was dealing with liquidity pressures triggered by sudden build-up in government cash balances occasioned by the larger than anticipated level of 3G spectrum and broadband wireless access auction realisations. Through the month of June, liquidity under LAF operations remained in deficit mode. Consequently, the call rate moved up significantly, resulting in an effective tightening at the short end of the yield curve. The liquidity situation has since begun to ease."

So what does the market expect from the RBI in its Monetary Policy review on July 27?

There could be one more round of rate hike when the Reserve Bank of India (RBI) meets for a policy review on July 27 because of inflationary pressure in the economy, Adviser to the Prime Minister C Rangarajan says.

OB Bhatt, Chairman of the State Bank of India does see more policy action on July 27 but till then the interest rates will not get impacted, he says.

Arvind Sampath of Standrard Charterd Bank says the market expects another 25 basis points hike from the policy.

Though voicing a similar opinion, Shubhada Rao, Chief Economist, YES Bank says the hike would depend on two conditions. "One is how quickly the liquidity situation improves and two what is the next inflation number going to be given the kind of food inflation which year on year may have eased but sequentially has not eased the impact of the fuel price hike. The 25 basis now and the compulsion may prompt the RBI to look at another 25 basis points on July 27 but it is a close call."

"July 27 is almost three weeks away. I suppose that RBI could take a view. We will see how the liquidity in the system moves during these three weeks. If there is no serious cost to liquidity there is a possibility there could be one more," says S Ranjan CFO of SBI.

KR Kamath, Chairman of PNB, states that the actions are initiated based on the prevailing circumstance so these actions get some results immediately. "Probably the 27 may not bring surprises," he adds.