RBI raises key rates by 25 bps to lid prices

The Reserve Bank of India raised policy rates for the eighth time in a year by the expected 25 basis points to tackle inflation that is running disproportionately higher with a potential to whittle down the government's cherished 9% economic growth.

Come April, borrowers will pay more per month on their home and car loans. Companies' interest expenses will go up as banks raise their lending rate to pass on higher cost of deposits in the last two months.

"The action by itself is not a surprise," said Shikha Sharma , chief executive at Axis Bank . "Much of these hikes would be passed on. We cannot predict the exact timing, but it will get passed on."

The central bank said economic expansion is at risk as soaring commodity and oil prices due to civil strife in North Africa and West Asia could affect investments even as it pursues anti-inflationary policy.

It lifted inflation forecast by 1 percentage point to 8%, from 7% set in January as price rise is spilling over to manufactured products from food articles. Inflation in February was at 8.31%. Current account deficit is forecast to fall to 2.5%, from 3.5% of gross domestic product on rising exports.

Repo rate, the rate at which the RBI lends to banks, has been raised 25 basis points to 6.75% which is still 1.55 percentage points lower than the inflation rate. Reverse repo, the rate it pays banks for deposits, has been raised by a similar proportion to 5.75%. A basis point is 0.01 percentage point. All other rates remain unchanged. The next monetary policy review is scheduled for May 3.

"Underlying inflationary pressures have accentuated, even as risks to growth are emerging," said the central bank statement on mid-quarter monetary policy review. "Rising global commodity prices, particularly oil, are a major contributor to both developments. As domestic fuel prices are yet to adjust fully to global prices, risks to inflation remain clearly on the upside, reinforced by the persistence of demand-side pressures as reflected in non-food manufacturing inflation."

Crude oil prices touched $120 a barrel recently due to supply disruptions in West Asia, the biggest exporting region in the world, as most authoritarian governments face revolt. Other commodities such as copper and rubber were at record highs as Western economies show signs of recovery. But last week's earthquake in Japan has complicated forecast.

"It is as yet too early to assess the macroeconomic consequences of the natural disaster in Japan," said the RBI. "Substitution of thermal for nuclear energy in Japan may exert further pressure on petroleum prices."

Finance Minister Pranab Mukherjee is hopeful that RBI's measures will have the desired effect. "It will have its impact on the inflationary pressure," Mukherjee said. "I do hope it will have a salutary impact on inflationary pressure."

Sustained high inflation is threatening to derail growth with a bigger portion of income being eaten away by higher prices. What was once thought to be limited to food items is spreading to manufactured products that will prevent easing of inflation rate even if food prices cool. The Wholesale Price Index is rising at more than 8% now, from 1.5% in March 2009 when the repo rate was at 5%.

The baby steps by Governor Duvvuri Subbarao may dent the central bank's credibility in tackling inflation since market rates have accelerated more than the RBI's policy rates.