RBI surprises with 0.25% rate hike; EMIs on loans to go up

Mangalore Today /DHNS

Mumbai, Sept 20, 2013: EMIs on auto, home and other loans are set to go up after RBI Governor Raghuram Rajan unexpectedly raised the policy rate by 0.25 per cent, the first increase in almost two years, to keep inflation under check, sending the stock markets into a tizzy.

Contrary to the expectations of the industry and experts, Rajan in his maiden policy review opted for a hawkish monetary stance ahead of the festive season instead of shifting the focus to growth promotion by lowering interest rates to generate demand.

The repo rate, or the short-term lending rate, has been increased by 25 basis points to 7.5 per cent from 7.25 per cent with immediate effect. Other policy rates will be adjusted accordingly. The RBI previously raised the repo rate in October 2011 by 0.25 per cent to 8.5 per cent.

The RBI Governor, however, took steps to ease liquidity through a reduction in the marginal standing facility (MSF) rate, at which banks borrow from the central bank, by 0.75 per cent to 9.5 per cent and a lowering of the minimum daily maintenance of the cash reserve ratio (CRR).

After the policy was unveiled, State Bank of India Chairman Pratip Chaudhuri said lending and deposit rates will go up in view of the rise in festive season demand.

Rajan, however, did not indicate that banks would raise lending rates, saying the cut in the MSF rate would balance the impact of the repo rate hike.

"I hope that they (banks) will look at their cost of funding... to make a decision and not look at the future and try and anticipate some hypothetical cost," he added.

Following the policy announcement, the benchmark S&P BSE Sensex tanked by as much as 595 points, while the rupee depreciated 69 paise to 62.46 against the dollar.

The RBI said the elevated level of retail inflation is worrisome and leaves no room for complacency, while wholesale price inflation will be higher than initially anticipated.
Retail inflation was at 9.52 per cent last month. Wholesale price inflation rose to a six-month high of 6.1 per cent in August, driven by costlier food items.

"The need to anchor inflation and inflation expectations has to be set against the fragile state of the industrial sector and urban demand. Keeping all this in view, bringing down inflation to more tolerable levels warrants raising the repo rate by 25 basis points immediately," Rajan said in the policy statement.

Rajan said WPI inflation will be higher than initially projected over the rest of the year in the absence of an appropriate policy response.

"RBI always looked at both rates... We have to take everything into account because WPI does not contain, for example, a significant portion of services inflation. So you cannot just focus on one," he said.

CII Director General Chandrajit Banerjee said the repo rate hike could have been avoided as the industry is already reeling under pressures of high cost of capital and low availability in a tight liquidity situation.

"The increase in repo rate comes as a surprise," Banerjee said.

Stating that economic growth has weakened with continuing sluggishness in industrial activity and services, the RBI said the pace of infrastructure project completion is subdued and the start of new projects remains muted.

Observing that growth is trailing below potential and the output gap is widening, Rajan said, "Some pick-up is expected on account of the brightening prospects for agriculture due to kharif output and the upturn in exports."

He said concerns on the current account deficit have been mitigated with measures taken by the government and the RBI.

Rajan said the timing and direction of further actions on exceptional measures will be contingent upon exchange market stability and can be two-way.