October 29, 2013 / 12:41 IST
The Reserve Bank of India Tuesday raised the benchmark repo rate by 25 basis points to 7.75 points, reduced the marginal standing facility (MSF) rate by 25 basis points to 8.75 percent, and sought to improve money flow in the system by making available more short term funds to banks.
The move is expected to further cool down short term rates, which had surged after the RBI tightened liquidity in July this year to protect the rupee.
The central bank increased short term funds available for banks under the 7-day and 14-day repo by doubling the limit to 0.5 percent of deposits, which is expected to release around Rs 20,000 crore into the system.
As mentioned in its macro-economic report on Monday, the RBI reiterated its warning that both wholesale and consumer inflation would remain high for the rest of this financial year, and hinted at further rate hikes if the situation so warranted.
The tone of the policy makes it clear that tackling inflation will the RBI’s top priority, a move which some economists fear may cause long term damage to growth while achieving short-term results.
On its part, the RBI is hoping that strengthening export growth, signs of revival in some service, a pick-up in agriculture and the revival of stalled projects, and approvals for few ones could boost investment and overall activity towards the close of the year.
Still, inflation is likely to be a thorn in the flesh of the economy.
“While food price pressures may ease with the arrival of the kharif harvest and the usual seasonal moderation, overall WPI inflation is expected to remain higher than current levels through most of the remaining part of the year,” the RBI policy said.
“Notwithstanding the expected edging down of food inflation, retail inflation is likely to remain around or even above 9 per cent in the months ahead, absent policy action,” the policy said.
The RBI justified the raising of repo rate by saying it was “important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth.”
In the policy statement, the RBI said that a better strategy for banks to meet their funds mismatch would be step up efforts to mobilize deposits. Given the backdrop of high inflation, banks will have to continue offering high deposit rates to attract savers.
The RBI has lowered FY14 GDP growth forecast to 5 percent from 5.5 percent earlier.
The RBI said that with this simultaneous reduction in MSF rate and increase in repo rate, “process of re-aligning the interest rate corridor to normal monetary policy operations is now complete.”
