RBI raises rates for fourth time this year

The Reserve Bank of India on Tuesday raised its key policy rates for the fourth time this year, taking more steps to tame rising prices amid a strong rebound in the economy.

As widely expected, the RBI raised the repo rate by 25 basis points (bps) to 5. 75 per cent in its credit policy review. But the reverse repo rate has been hiked by a slightly higher-than-expected 50 bps to 4.5 per cent. The cash reserve ratio has been kept unchanged at 6 per cent.

One basis point is one-hundredth of a percentage point. The repo rate is the rate at which the RBI infuses cash into the system or banks borrow from the RBI. The reverse repo rate is the rate at which the central bank drains cash from the banking system, or the rate at which banks lend to the RBI.

In an NDTV poll, 12 out of 15 bankers expected a 25 bps hike in repo and reverse repo rates.

Since the RBI did not spring any negative surprise by going for a steep rate hike, Indian markets reacted mildly positively to the rate hike announcement. It was trading flat-to-positive in the early noon trade.

The RBI said that the rate hikes will help to rein in demand pressures and moderate inflation. The central bank also raised its economic growth target for FY11 to 8.5 vs 8 per cent earlier.

Earlier this month on July 2, the RBI in an unscheduled move had raised the key rates by 25 bps to tame inflation, which is still in double-digits, led by high food prices. Inflation for June stood at 10.55 per cent and it is expected to stay in double-digits at least for another couple of months. The July inflation is likely to move further up as the full impact of the oil price hike which was effective from June 25 would be felt during the month.

Despite a sharp rebound in the domestic economy, the RBI has refrained from steep hikes, partly due to an optimistic inflation outlook and fears that a big rise in interest rates will derail the economic recovery process. The tight liquidity in the banking system also had a bearing on its decisions.

Prime Minister Manmohan Singh recently said that expects inflation to ease and reach 6 per cent by December. The government hopes that a normal monsoon will boost supplies of summer-sown crops and help bring down food prices.

"Going by the progress of the monsoon so far, agricultural output is expected to be better than last year. Lead indicators for services activities suggest continuation of the growth momentum," the Reserve Bank said in its Macroeconomic and Monetary Developments: First Quarter Review 2010-11, which was released on Monday.

It cited the prospect of a better Kharif output than last year, buoyancy in the industrial sector, notwithstanding the moderation in May and a significant pick-up in investment demand as major factors giving a positive growth outlook.