RBI monetary policy stuns markets; repo rates hiked, MSF cut

Updated: Friday, September 20, 2013, 11:22 [IST]

If US Fed Chairman Ben Bernanke surprised positively, his Indian counterpart surprised negatively by hiking the repo rate (rates at which banks borrow from the RBI) by 0.25%, which came as a pleasant surprise for the markets. Hike in repo rates normally lead to higher interest rates in the economy, which is not good for economic growth. However, higher interest rates are needed to tame inflation.

This was the first monetary policy under new Governor Raghuram Rajan, which actually stunned the stock markets with banking stocks collapsing in trade today.

The RBI today also reduced the marginal standing facility (MSF) rate by 75 basis points from 10.25 per cent to 9.5 per cent with immediate effect.

Under the MSF banks were borrowing from the RBI at repo rate, plus 1 per cent, which effectively meant 8.25 per cent. But, with effect from July 17, banks would have been borrowing at 10.25 per cent. This rate now stands reduced by 75 basis points, as against market expectations of 0.25%.
The RBI also reduced the minimum daily maintenance of the cash reserve ratio (CRR) from 99 per cent of the requirement to 95 per cent effective from the fortnight beginning September 21, 2013, while keeping the CRR unchanged at 4.0 per cent; and
Today's hike in repo rates would possibly increase lending rates in the economy and action that is worrying for growth.

But clearly, the RBI was worried about inflation.

"WPI inflation, which had eased in Q1 of 2013-14, has started rising again as the pass-through of fuel price increases has been compounded by the sharp depreciation of the rupee and rising international commodity prices.

The negative output gap will exercise downward pressure on inflation, and the process will be aided as supply side constraints, especially relating to food and infrastructure, ease. However, the current assessment is that in the absence of an appropriate policy response, WPI inflation will be higher than initially projected over the rest of the year.

What is equally worrisome is that inflation at the retail level, measured by the CPI, has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence. Although better prospects of a robust kharif harvest will lead to some moderation in CPI inflation, there is no room for complacency," the RBI said in its policy statement.

Stock markets tanked following the RBI decision with banking stocks dropping like a pack of cards.

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