RBI frees savings deposit rates,hints pause in further rate hikes

Banks are now likely to increase lending rates as they have not raised interest rates following the September review of credit policy. With the latest round of rate hike,banks would have to readjust rates in line with the increase in cost of funds.

Despite the 25 basis point hike in policy rates,the BSE Sensex shot up by 316 points to nearly a three-month high of 17,254.86 as the central bank hinted at a pause in further lending rate hikes.

The second quarter monetary policy statement,unveiled by the central bank,suggested that “the likelihood of a rate action in the December mid-quarter review is relatively low”.

“If the inflation trajectory conforms to projections,further rate hikes may not be warranted,” RBI Governor D Subbarao said.

Cheering depositors on Diwali eve with deregulation in the SB deposit interest rate with immediate effect,the RBI said banks are free to determine their savings bank deposit rate if they meet two conditions. Each bank will have to offer a uniform interest rate on savings bank deposits up to Rs 1 lakh,irrespective of the amount in the account within this limit.

“Second,for savings bank deposits over Rs 1 lakh,a bank may provide differential rates of interest,if it so chooses. However,there should not be any discrimination from customer to customer on interest rates for similar amount of deposit,” Subbarao said.

Currently,the savings bank rate stands at 4 per cent,which was last raised in May after remaining unchanged for 8 years. Yes Bank hiked the SB rates by 200 basis points to 6 per cent soon after the RBI move.

On the monetary tightening,Subbarao said,“both inflation and inflation expectations remain high. Inflation is broad-based,and is above the comfort level of the Reserve Bank. We expect these levels to persist for two more months. There are potential risks of expectations becoming unhinged in the event of a pre-mature change in the policy stance.”

Indicating that it might halt the tightening soon,he said,“reassuringly,momentum indicators,particularly the de-seasonalised quarter-on-quarter headline and core inflation measures,indicate moderation. This is consistent with the projection that inflation will decline beginning December 2011.”

The RBI chief said growth is clearly moderating on account of the cumulative impact of past monetary policy actions as well as some other factors.

“As inflation begins to decline,there will be growing room for the policy stance to give due consideration to growth risks,within the overall objective of maintaining a low and stable inflation environment. While the impact of past monetary actions is still unfolding,based on our growth-inflation dynamics,we considered it necessary to persist with the anti-inflationary stance.”

Responding to the RBI action,Finance Minister Pranab Mukherjee said today’s policy announcement would help in getting back to a more comfortable inflation situation soon while leaving scope for growth to pick up in the second half of the current fiscal year.

“The RBI has signalled a transition in the stance by indicating that the likelihood of another rate hike is low given the likely moderation in inflation going forward,” ICICI Bank MD and CEO Chanda Kochhar said.

Giving guidance for the period forward,Subbarao said the projected inflation trajectory indicates that the rate will begin falling in December 2011 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.”

He said these expected outcomes provide some room for monetary policy to address growth risks in the short run.

However,he warned that several factors — structural imbalances in agriculture,infrastructure capacity bottlenecks,distorted administered prices of several key commodities and the pace of fiscal consolidation — combine to keep medium-term inflation risks in the economy high.

“These risks can only be mitigated by concerted policy actions on several fronts. In the absence of progress on these,over the medium term,the monetary policy stance will have to take into account the risk of inflation surging in response to even a moderate growth recovery,” he said.

On the measures taken by the RBI,he said,“first,on the basis of a credible commitment to low and stable inflation,medium-term inflation expectations will remain anchored. Second,the emerging trajectory of inflation,which is expected to begin to decline in December 2011,will be reinforced. And finally,it will contribute to stimulating investment activity.”

The reverse repo rate (the lending rate for banks to the RBI),determined with a spread of 100 basis point below the repo rate,will rise to 7.5 per cent. Similarly,the marginal standing facility (MSF) rate,determined with a spread of 100 bps above the repo rate,stands adjusted at 9.5 per cent. The RBI also kept the bank rate and cash reserve ratio unchanged at 6 per cent each.