India’s central bank cracks the whip on inflation (Lead)

July 29th, 2008 - 3:56 pm ICT by IANS  

Mumbai, July 29 (IANS) In a bid to contract the money supply and tame inflation, India’s central bank Tuesday hiked a key lending rate and the minimum cash banks have to retain against deposits, in a move that is expected to make loans for homes, consumer durables and the corporate sector dearer. In the quarterly review of the monetary policy for this fiscal, Reserve Bank of India (RBI) Governor Y.V. Reddy said the repo rate, or the short-term lending rate, and the cash reserve ratio (CRR), were being hiked by 50 basis points and 25 basis points, respectively.

The repo rate stands revised for the third time in three months to 9 percent, while the CRR will also be hiked to 9 percent from the fortnight beginning Aug 30, 2008, the central bank said in a statement.

This has made the short-term lending rate climb to a seven-year high and is expected to prompt commercial banks to also revise upward their interest rates on loans for homes, automobiles, consumer durables and to the corporate sector.

A position on the rate hikes will be taken over the next few days, said the chief executives of some commercial banks, adding that while they expected a tight policy stand by the RBI, the quantum of revision was rather unexpected.

The central bank’s previous interventions this fiscal had sucked Rs.40,000 crore (Rs.400 billion or $10 billion) out of the financial system.

“At this juncture, a realistic policy endeavour would be to bring down inflation from the current level of about 11-12 percent to a level close to 7 percent by March 31, 2009,” the RBI statement said.

“In view of the evolving environment of heightened uncertainty in global markets and dangers of potential spill-over to domestic markets, liquidity management will continue to receive priority in the hierarchy of policy objectives.”

The central bank also said that its policy actions would aim to bring down the current intolerable level of inflation to a tolerable level of below 5 percent as soon as possible and around 3 percent over the medium-term.

“Bringing down inflation from the current high levels and stabilising inflation expectations assumes the highest priority in the stance of monetary policy,” the statement said, triggering a nearly 4 percent drop in a key equity market index.

A far higher impact was on the banking sector index of the Bombay Stock Exchange that was down nearly 8.2 percent an hour after the policy review was announced by the central bank.

The review, nevertheless, kept the reverse repo rate, another instrument to hold back excess cash from banks, unchanged at 6 percent. Similarly the bank rate, or the long-term interest on banks loans was also left untouched at 6 percent.

Reacting to the policy review, the finance ministry said if commercial banks appraise and allocate request for loans prudently, it was possible to maintain the flow of credit to consumers and industry.

“The government expects that the measures taken by RBI today (Tuesday), in continuation of the measures already taken over the last two months, will help in moderating and containing inflation,” the ministry said in a statement.

Looking at other fiscal and monetary developments, the RBI said that it was also lowering India’s economic growth projection to 8 percent for the current fiscal from 8-8.5 percent when it presented the monetary policy in April.

It said while its monetary policy accords high priority to price stability, a well-anchored inflationary expectation and orderly conditions in financial markets, it would also be conducive to continuation of the growth momentum.

Indian industry was clearly disappointed at the announcements, having requested the central bank to maintain a status quo on interest rates so as not to impact the growth momentum.

“The tightening of the money supply may lead to a fall in the overall business confidence with companies postponing their investment plans in the times to come,” warned Associated Chambers of Commerce and Industry (Assocham).

“As the current inflation is due to the supply crunch hitting globally, the hike in the policy rates may not be able to scale down the impact of rising prices,” Assocham president Sajjan Jindal said.

“It is thus necessary to address to the supply side inefficiencies to bring down the rising prices to the central bank’s comfort zone,” he said, adding that the hikes in CRR and repo rate could underpin the economic slowdown.

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