RBI hikes the repo rate and cash reserve ratio (CRR) by 50 basis points: Banknet India

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Reserve Bank of India hikes the repo rate and cash reserve ratio (CRR) by 50 basis points

June 24, 2008: Consistent with the stance of monetary policy and on the basis of incoming information on domestic and global macroeconomic and financial developments, Reserve Bank of India has decided to take the following measures:

a) The repo rate under the Liquidity Adjustment Facility (LAF) is increased from 8.00 per cent to 8.50 per cent with immediate effect.

(b) The cash reserve ratio (CRR) of the scheduled commercial banks, regional rural banks (RRBs), scheduled state co-operative banks and scheduled primary (urban) co-operative banks is being increased by 50 basis points to 8.75 per cent in two stages, effective from July 5, 2008 ( 8.50) and July 19, 2008 (8.75) respectively.

Important developments have taken place in recent weeks with regard to inflation. To assess these developments, it is important to recognise the key forces at work. The escalation in inflation last week mainly reflects the pass-through of international crude prices to domestic prices effected on June 5, 2008. Unlike in some mature economies, however, the pass-through is not occurring on a continuous basis in developing economies including India. Thus, the policy response to the escalation in crude prices could be somewhat similar to other countries but tailored to suit our conditions.

Besides oil prices, there are some underlying inflationary pressures impacting inflation in India. Inflation, based on variations in the wholesale price index (WPI) on a year-on-year basis, increased to 11.05 per cent as on June 7, 2008 from 7.75 per cent at end-March 2008 and 4.28 per cent a year ago. Excluding the fuel sub-group, inflation rose to 9.61 per cent from 5.92 per cent a year ago. Excluding fuel and food, inflation was 10.33 per cent as against 6.33 per cent in the corresponding period of the preceding year. inflation based on the consumer price index (CPI) for industrial workers (IW) and urban non-manual employees (UNME) stood at 7.81 per cent and 6.99 per cent, respectively, on a year-on-year basis in April 2008 as compared with 6.67 per cent and 7.74 per cent a year ago. Inflation based on CPI for agricultural labourers (AL) and rural labourers (RL) stood at 9.11 per cent and 8.84 per cent in May 2008, respectively, as compared with 8.22 per cent and 7.90 per cent a year ago. Therefore, it is important to recognise that an adjustment of overall aggregate demand on an economy-wide basis is warranted to ensure that generalised instability does not develop and erodes the hard-earned gains in terms of both outcomes of and positive sentiments on India's growth momentum.

The urgency of this broader, albeit somewhat painful but timely contraction has to be viewed in the context of the new reality of high and volatile energy prices not necessarily being a temporary phenomenon any longer. Monetary policy recognises the need to smoothen and enable this adjustment so that inflation expectations are contained. The Reserve Bank has been acting pre-emptively from April 2008 onwards, keeping in view the lagged effects of such measures on the economy. Accordingly, the cash reserve ratio (CRR) was raised by 25 basis points each from the fortnights beginning April 26, May 10 and May 24, 2008. On May 30, 2008 special market operations were announced to alleviate the binding financing constraints faced by public oil companies in importing POL as also to minimise the potential adverse consequences for financial markets in which these oil companies are important participants. Subsequent to the announcement of the oil price hike, the repo rate was increased by 25 basis points on June 11, 2008.

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