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RBI Raises Rates by 0.25% to 8.5%

RBI has raised interest rates by 0.25%, taking the repo rate to 8.5% and the reverse repo to 7.5%. The repo rate is what banks pay to borrow overnight from the RBI (against the collateral of government securities) and the reverse repo rate is what banks receive from the RBI for depositing money.

This is the 13th time rates have been raised since March 2010 (when it was at 4.75%).


The Cash Reserve Ratio, or CRR, which is the percentage of deposits banks need to keep as reserve with the RBI, stays at 6%.

RBI indicates that there may not be further hikes this year:

The projected inflation trajectory indicates that the inflation rate will begin falling in December 2011 (January 2012 release) and then continue down a steady path to 7 per cent by March 2012. It is expected to moderate further in the first half of 2012-13. This reflects a combination of commodity price movements and the cumulative impact of monetary tightening. Further, moderating inflation rates are likely to impact expectations favourably. These expected outcomes provide some room for monetary policy to address growth risks in the short run. With this in mind, notwithstanding current rates of inflation persisting till November (December release), the likelihood of a rate action in the December mid-quarter review is relatively low. Beyond that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted. However, as always, actions will depend on evolving macroeconomic conditions.

They expect GDP growth to go down to  7.6% for 2011-12. This is a result of both monetary action and global developments.

In terms of money supply, they expect M3 to grow by 15.5% (it’s currently at 16.5%)

Bank Savings Rate Deregulated

Savings Bank accounts have been giving a rate of 4% (recently upgraded from 3.5%). This was a fixed rate, and many banks used that low rate to good effect, offering customers substantial benefits if they kept money in an SB account.

Now, the RBI has changed this policy and allowed banks to set their own rates for SB accounts. With two restrictions:

a) All amounts below Rs. 1 lakh should get a uniform interest rate (per bank).

b) For above Rs. 1 lakh, banks can have a different interest rate based on amount, but banks can’t differentiated based on customer (like “premier” or “senior citizen” or whatever).

While this is prima-facie negative for banks, do not underestimate their ability to act like a cabal and collectively keep interest rates low. To avoid such a deal, I will note how banks change their SB rates and accordingly, move my transactional money to different accounts (currently HDFC bank).

Home Loan Pre-payment penalty removed (Most likely)

The RBI statement is:

Customer service has always been on top of the Reserve Bank’s policy agenda.  Recognising the need for revisiting the issues of customer service in banks, the Reserve Bank constituted the Damodaran Committee to make recommendations for improving customer service. The Committee has made several recommendations to improve customer service.  We have decided to implement the recommendations of the Committee, on which a broad consensus has emerged, as also the action points which were identified by the Indian Banks’ Association (IBA) and Banking Codes and Standards Board of India (BCSBI) in the last Banking Ombudsmen conference.

That committee has recommended removal of pre-payment penalty for floating rate loans completely, and also for fixed rate loans where you don’t refinance the loan from another bank.

This is negative for banks. Great for everyone else, obviously.

Other Changes

Banks can also open branches without permission in Tier 2 areas (population from 50,000 to 1 lakh) – this was earlier limited to Tiers 3 to 6 only.

They will let Credit Default Swaps (single name corporates happen after end-November 2011. These should have started yesterday and were postponed.

RBI will also allow short selling of Govt securities with a clearer policy by end-December. Plus, market traded 2 and 5 year interest rate futures will be allowed, and they will look to expand liquidity in the G-Sec markets (please involve retail!).


Obviously banks are hurt, and the bank index is down 2.5%. HDFC Bank is down over 5.5%, while ICICI is only down 1%. Yes Bank, on the other hand, is up 3%.

Bond yields at the 10 year G-Sec were down to 8.68% from the 8.84% seen yesterday, perhaps more of a relief rally after the fear of a 50 bps hike.

Given that it is expiry day, and volumes recently have been low, and this is Diwali week involving holidays the next two days, I would not give too much importance to movements today. What is important now is to hear how banks change their lending and deposit rates, and to brace for the lower growth rate that RBI is talking about. I believe we will slow down substantially more by 2013, with inflation remaining high after March (when the base effect is gone).

  • DJ says:

    RBI is the dumbest central bank out there. What is the need to indicate that they are likely to not tighten next time around? This will cause all the people to position themselves for no more hikes. Then, if inflation happens to be persistent, RBI will have to backtrack and it will cause problems for the market. When you are fighting inflation, it is counter-productive to signal earlier than needed that you are almost done. Dumb, dumb, dumb!

    • DJ says:

      “The projected inflation trajectory indicates…” cringe – what about the nonsensical way in which the inflation index is calculated? What about the fact that RBI projections are usually off the mark?

    • Good point. All the rupee has to do is depreciate another 10% and even in December we’ll see inflation at 10%. It’s a little strange, but other banks have done the same – the US fed has said no change till 2013 or something, when it has no idea if inflation will go nuts in that time etc.

      • DJ says:

        But, the US does not want to control inflation. It wants inflation. There, the risk is to the other side. If the US wants to contain inflation today, it would be mighty easy for them. Compare India against China… that is a bit more appropriate. China isn’t out there blowing its horn that inflation might come down and that they might be done raising rates (even though they might be).

  • Arghya says:

    It seems I might be the only one to defend RBI. See it’s not an easy job. Can’t be more agree with you that there was no need for any indication about the next round of rate hike. But then there would have been a criticism that RBI is hiking rate without any rationale.
    Perhaps RBI is more concern about GROWTH, so doesn’t want to create panic; it wants industries to remain less worried about interest rate hike – this helps growth. The futuristic talk is targeting Growth and not Inflation.
    Regarding FED – Same theory applies. US economy is in deep shit. FED’s comment of “no interest rate change…” represent the agony of US growth prospects. But it is no way true that they want inflation. All develop countries reserve bank’s primary objective is to curb Inflation by supplying right amount money in the economy. US might want devaluation of their currency but not inflation.

  • Veera says:

    I think the US Fed wants to create inflation probably that is their target, they dont want price stability any more they want inflation. US Fed is probably aware that the stimulus is wearing off and hence have decided to keep interest rates same till 2013, i think they are targeting price rise now and not price stability anymore

  • Rudra Chowdhury says:

    Hi Deepak,
    You mentioned “The reverse repo rate is what banks pay to borrow overnight from the RBI (against the collateral of government securities) and the repo rate is what banks receive from the RBI for depositing money.”
    Isn’t it just the opposite ??
    Bank’s borrow at Repo Rate ( 8.5%) from RBI.
    If they park excess cash they will earn reverse repo ( at 7.5% ) from RBI by parking excess cash.

  • bemoneyaware says:

    Why did different Banks went down by difference %: HDFC Bank is down over 5.5%, while ICICI is only down 1%. Yes Bank, on the other hand, is up 3%.? HDFC Bank down so much baffles me

  • bemoneyaware says:

    Inflation will come down. read on equitymaster quoting them.
    The Economic Affairs Secretary actually expects inflation rates to trend downwards in the coming months. He has given a forecast that the inflation rates would come down to 7% by March 2012. And as unbelievable as it sounds, experts actually agree with him.
    However, the reason for this is not because the prices would come down. It is simply due to the base effectt. So what does this mean? It means that due to the high rate of inflation recorded during March 2011, the percentage change in prices for March 2012, would appear to be low. It is just a statistical phenomenon. Nothing more than that. And other than the fact that it will make the government look in a better position, it would not really be of any help for the ‘common man’.

  • RBI policy measures won’t do alone if we are looking forward to keep the inflation in the check. In my views both the fiscal and monetary policy should work in tandem in order to have some concrete results otherwise such moves would continue to remain inefficient and ineffective.