Cautious Rajan hikes repo by 25 bps; Street slumps

The unexpected hike in interest rates by the new Reserve Bank of India Governor, Raghuram Rajan, caught the corporate sector by surprise and spooked the stock market. In fact, the hike in the repo rate eclipsed the equally significant cut in Marginal Standing Facility (MSF) rate.

In his maiden monetary policy review Rajan raised the repo rate (at which the RBI lends money to banks) from 7.25 per cent to 7.50 per cent to bring down inflation to more tolerable levels. On the other hand, the Governor reduced the MSF rate (at which banks can get overnight funds from the RBI against their excess holding of government securities) by 75 basis points, at 9.50 per cent down from 10.25 per cent, in order to ease the liquidity situation.

It was widely expected that the central bank would stay pat on interest rates as inflation is ruling high and economic growth remains tepid.

>Highlights of the monetary policy review

Though the RBI sought to offset the impact of the repo rate hike by easing some of the liquidity tightening measures taken by it in mid-July to dampen volatility in the foreign exchange market, the market was clearly upset.

The markets gave a thumbs down to the Governor’s maiden monetary policy review, pulling down the benchmark indices.

>Costlier food items sent wholesale price inflation to a six-month high of 6.1 per cent in August .

The 30-stock BSE S&P Sensex ended down 382.93 points or 1.85 per cent at 20,263.71, while the NSE index Nifty fell 103.45 points or 1.69 per cent at 6,012.10 points. Nine stocks in the Sensex, including ICICI Bank, L&T, Sesa Goa, HUL, HDFC Bank, Hindalco and SBI, slipped more than 3 per cent.

The rupee ended 50 paise weaker at 62.27 to the dollar against the previous close of 61.77.

Yield on the 10-year benchmark government security, which carries a coupon rate of 7.16 per cent, jumped 38 basis points, while its price declined a sharp 240 paise. Bond yields and prices move in opposite directions.

Liquidity easing STEPS

The cut in MSF means banks can now get funds from RBI on an overnight basis against their excess holding of government securities at the reduced interest rate of 9.50 per cent.

Further, the minimum daily cash reserve ratio (CRR) balance that banks have to maintain with the central bank has been reduced to 95 per cent from 99 per cent earlier. CRR, which is the slice of deposits that banks have to park with the RBI, is currently at 4 per cent of deposits.

The Governor emphasised that the MSF rate cut will significantly reduce banks’ cost of funding. The 25 basis points repo rate increase is only marginal, he added.

Deposit, lending rates

Bankers say the hike in repo rate coupled with the demand pick up in the upcoming festival season could push up deposit and lending rates.

Care Ratings, in a report, said the effect of reduction in MSF and increased repo would reduce the cost of borrowing for the banking system by around Rs 250 crore — in percentage terms it would be around 3 per cent, indicating only a marginal impact on the banking system.

“The increase in repo rate will put pressure on banks to revise their deposit and lending rates,” the report said.

Reacting to the policy statement, FICCI President Naina Lal Kidwai said: “The increase in the repo rate by 25 basis points has come as a surprise to us. The RBI has admitted that industrial activity continues to remain sluggish and even consumption demand is now starting to weaken in the economy. In such a scenario, a positive signal by way of a cut in the repo rate would have helped perk up sentiments.”