>Mid-Quarter Monetary Policy Review: Inflation continues to be RBI’s priority

RBI hikes repo (25bp) and reverse repo rates (50bp)
■ Hikes repo rate by 25bp to 6.0%
■ Hikes reverse repo rate by 50bp to 5.0%
■ Keeps cash reserve ratio unchanged at 6.0%

Inflation RBI’s priority in FY2011
The Reserve Bank of India in its maiden mid quarter monetary policy review
raised interest rates for the fifth time since mid March 2010 with an objective to
control inflationary expectations. It raised the repo rate (the rate at which it lends
to banks) and reverse repo (the rate at which it accepts surplus liquidity from
banks) by 25bp and 50bp to 6.0% and 5.0%, respectively. Effectively, this reduced
the Liquidity Adjustment Facility (LAF) corridor to 100bp after a reduction of 25bp
in July 2010 policy as well. The Central Bank has maintained status quo on Cash
Reserve Ratio (CRR) at 6.0%.

Monetary Policy - Key takeaways
■ Inflation remains the dominant concern for hiking the rates.

■ Expectation of rate hike not disrupting growth.

■ GDP and IIP growth rates indicate that the recovery is consolidating and the economy is rapidly converging to its trend rate of growth.

■ Monetary tightening that has been carried out since October 2009 has taken the monetary situation close to normal.

■ Central fiscal deficit to be contained at targeted 5.5% on account of higher than expected realizations from 3G and BWA auctions coupled with buoyant tax revenues.

The growth momentum in the Indian economy continued to be strong and was largely broad based, with IIP registering robust growth of 13.8% yoy in July 2010 coupled with healthy credit growth of 19.4% yoy in August 2010. On the other hand, continuing food inflation (14.6% yoy) has kept the overall WPI (8.5% yoy as per 2004-05 series) above RBI’s tolerable levels. Thus, with the headline inflation clearly above the RBI’s target of 6.5% as well as sustained healthy uptick in credit growth in the last few months, we expect gradual monetary tightening to continue.

To read the full report: MONETARY POLICY