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RBI raises Repo to 6%, Rev Repo to 5%


RBI raised interest rates today and both Repo and Reverse Repo went up to 6% and 5% respectively (increase of 0.25% and 0.5%).

In their statement:

Inflation remains the dominant concern in macroeconomic management. The published wholesale price index (WPI) inflation rate for August 2010 was based on the new series (base year: 2004-05=100) for the first time. The new series has better coverage of items and the manufacturing products group has a slightly higher weight. Both the old and the new series, however, indicate similar broad trend of inflation. For instance, average monthly WPI inflation for Q1 of 2010-11, based on either series, is in double digits. However, the monthly average of WPI inflation for Q1 of 2010-11 under the new series at 10.6 per cent was about 50 basis points lower than the rate of 11.1 per cent under the old series. In July 2010, there was a slight moderation in the provisional WPI inflation under both the series. There has been further moderation in the provisional WPI inflation to 8.5 per cent in August from 9.8 per cent in  July 2010 as per the new series. The direction of the inflation rate movement  is consistent with the Reserve Bank’s projection made in the July review, though the magnitude could be slightly different.

Inferences from both the series are similar. Essentially, inflation rates have reached a plateau, but are likely to remain at unacceptably high levels for some months. While prices of food articles, which according to the new series, rose by over 14 per cent in August, are still contributing to the pressure, about two-thirds of the August inflation can be attributed to items other than food articles and products. Notwithstanding slight moderation in August 2010, the headline inflation  remains significantly above the trend of 5.0–5.5 per cent in the 2000s. There is, therefore, need for continued policy response to contain inflation and anchor inflationary expectation.

With reference to government finances, the fiscal deficit appears to be conforming to the estimates made in the Union Budget for 2010-11. Higher than expected realisations on 3G and  broadband wireless access (BWA) auctions combined with buoyant tax revenues have virtually eliminated the risk of the fiscal deficit overshooting the targeted 5.5 per cent, even after the supplementary demand for grants is taken into account. This will help stabilise market expectations of liquidity and interest rate movements.

Bond yields didn’t budge – a 25 bps rise was entirely expected.

This they say will marginally increase interest rates both for deposits and loans. This in turn increases interest payments for the debted, and increases income for savers. Unfortunately the monetary link is broken – RBI’s changing rates translate either very slowly to the real market space or not at all. Inflation, if it will be moderated, will not be by interest rate changes (monetary policy) but by things like good rainfall helping food supply etc.

Unfortunately, the food inflation and fuel price hikes will reflect in manufactured goods – now a larger part of the index – much later when they can’t handle the rising input prices anymore. If or when that happens, the rates will be altogether difficult to control – they are of course sticky on the upside and wages will have to go up. With the weak monetary link, RBI’s only option – to raise rates further – will again be of little use, but they’ll have to do it anyhow. For the sake of the RBI and indeed the country, let’s hope inflation moderates on its own – or we’ll end up with an unmanageable situation.

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