In a bid to contain inflation and anchor inflationary expectations, RBI has announced a change in both the repo and reverse repo rates. The repo rate has increased by 25bps to 5.5% while the reverse repo rate has been increased by 50 bps to 4.5% with immediate effect. Bank rate, CRR and SLR have been left unchanged.
The move by RBI to increase reverse repo rates more than repo rates came as a surprise to most market participants. It has narrowed the corridor (the difference between the repo and the reverse repo rates) reducing the room for volatility in short term interest rates.
Growth in the economy has taken a firm hold allowing the Central bank to focus on inflation which in the uncomfortable territory. Also there are signs of demand-side inflationary pressures with pricing power returning to producers which may further spur inflation. So RBI has directed its efforts towards containing inflation and reining in inflationary expectation.
The RBI governor said that the policy actions are expected to moderate inflation by reining in demand pressures and inflationary expectations while maintaining financial conditions sustainable for growth. The governor also maintained that the narrowing of the corridor will reduce volatility of the short term interest rates.
RBIs policy tone is becoming increasingly hawkish. It is clear that containing inflation is the current priority. Liquidity management is also the focus so as to ensure that the policy actions are effectively transmitted in the economy.
RBI has announced a change in the policy review schedule. As per the current schedule, RBI is slated to make policy announcements once every quarter. In a rapidly evolving macroeconomic scenario, the time gap is too large making it essential for RBI to make announcements or changes in between policy reviews. In order to avoid such a scenario, going forward, the frequency of the policy review will increase from 4 times a year to 8 times with one policy review being introduced every mid-quarter and the actions in the mid-quarter review will be announced in the form of a press release. So the next RBI policy review is a mid quarter review, slated for September 16th, 2010.
Impact of policy actions
Increase in repo and reverse repo rates has an impact on both borrowing and lending costs. In an ideal scenario, it should result in an increase in both deposit and lending rates. However, it remains to be seen if bankers will act and increase their base rate on the basis of this policy change. If bankers decide to pass on this rate hike, it will mean loans will become costlier and hence it will result in higher EMIs for loan customers. For depositors, it may be good news as interest may be on the uptick.
Increasing the frequency of the policy reviews is in line with what the market was expecting for some time now. It will enable RBI to announce policy changes during the policy reviews eliminating the surprise element from it announcements. This is good for markets that tend to read into time the policy action has been taken.