India's New Central Bank Chief Unexpectedly Lifts Key Rates

ReserveBankOfIndia 092013

India's central bank unexpectedly lifted its benchmark repo rate by a quarter point to contain inflation, while also partially reversing some of the emergency measures taken recently to support the rupee after the Federal Reserve postponed the tapering of bond purchases.

At his maiden monetary policy meeting held on Friday, Reserve Bank of India Governor Raghuram Rajan raised the repo rate to 7.50 percent from 7.25 percent and adjusted the reverse repo rate to 6.50 percent.

The repo rate is the rate at which the central bank lends to banks and the reverse repo rate is the rate at which it accepts deposits from banks. The bank was widely expected to leave its repo rate unchanged at 7.25 percent.

The delay in Fed tapering and the subsequent strengthening of rupee helped the central bank to relax liquidity tightening in the banking system.

The marginal standing facility (MSF), the rate at which scheduled banks can borrow funds overnight from the RBI against approved government securities, was lowered to 9.50 percent from 10.25 percent with immediate effect.

The MSF was introduced under the governorship of Duvvuri Subbarao in May 2011 with an aim to contain volatility in the overnight inter-bank market. Subbarao raised the MSF by 200 basis points mid-July.

The RBI assessed today that it is now possible to contemplate easing these exceptional measures in a calibrated manner as the external environment has improved.

With these changes, the MSF rate and the Bank Rate are recalibrated to 200 basis points above the repo rate. Rajan said the gap between repo and the MSF will be lowered to 100 basis points.

Meanwhile, the cash reserve ratio was left unchanged at 4.00 percent as expected. But it reduced banks' minimum daily maintenance of the cash reserve ratio to 95 percent from 99 percent.

The bank said the timing and direction of further actions on exceptional measures will be contingent upon exchange market stability, and can be two-way. The bank also noted any action need not be announced only on policy dates.

Addressing the press conference, Rajan said calibrated withdrawal is required to support growth.

The RBI said the objective of the latest action is to normalize the conduct and operations of monetary policy so as to allow the repo rate to resume its role as the operational policy interest rate.

Rajan said concerns about the current account deficit has been mitigated by steps taken by the government and the RBI. Now the focus has turned primarily to fiscal deficit and domestic inflation.

Giving reasons for repo rate hike, Rajan said inflation is high and household saving is lower than desirable. In addition, the exchange rate depreciation will stoke inflationary pressure.

Bringing down inflation to more tolerable levels warrants a quarter point rate hike, he said.

In the absence of an appropriate policy response, wholesale price inflation will be higher than initially projected over the rest of the year. At the same time, economic growth is expected to pick up in the second half of the year.

Further, the bank vowed to closely and continuously monitor the evolving growth-inflation dynamics with a readiness to act pre-emptively as necessary.

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