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RBI hikes key interest rates; bank loans may turn costlier

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Repo, reverse repo raised; bank rate, cash reserve ratio unchanged

INFLATION CHECK: The RBI Governor, Dr Y.V. Reddy, and the Deputy Governor, Ms Shyamala Gopinath, at a press conference in Mumbai on Tuesday. — Paul Noronha

Mumbai , July 25

Interest rates on corporate and retail loans are set to go up as the Reserve Bank of India hiked its short-term lending rates on Tuesday for the second time in the last two months.

The reverse repo rate — the rate at which the RBI borrows funds from banks — has been raised by 25 basis points to 6 per cent. Consequently, the repo rate or the rate at which the RBI lends to banks has also risen to 7 per cent. These are the highest short-term rates in the last four years.

Indicating that inflationary pressures may continue due to global and domestic factors, Dr Y.V. Reddy, Governor of the RBI, said the decision to hike the rates was a pre-emptive measure to keep inflation between 5 and 5.5 per cent in the current year.

The central bank has kept its other rates such as the Bank Rate and CRR unchanged at 6 per cent and 5 per cent respectively.

This is the third hike in repo rates in the current year. The RBI had first hiked rates in January, then in June and now in July. Most banks raised their retail lending rates and prime lending rates after each RBI rate hike.

Banks, already under pressure from rising cost of funds, are expected to hike lending rates yet again.

Explaining the rationale in hiking the short-term rates just over a month after the previous hike, Dr Reddy said it was required in order to maintain "the informal, indicative, self-imposed ceiling of 5 per cent on inflation over the medium to long-term."

In its first quarterly review of the Monetary Policy announced on Tuesday, the RBI has maintained the GDP growth projection for 2006-07 at 7.5-8 per cent.

"The overall industrial outlook continues to be positive and services sector growth is expected to sustain its momentum. Overall for policy purposes, the forecast for GDP growth is retained in the range of 7.5-8 per cent, during 2006-07, barring domestic or external shocks," the policy said.

Momentum with stability

Addressing a press conference, Dr Reddy said, "We shall try to maintain the growth momentum with stability."

"The pass-through of international oil price increases is expected to be higher in the future than before, and policy authorities have to be on guard against second round effects. Taking into account the real, monetary and global factors, containing the year-on-year inflation rate for 2006-07 in the range of 5-5.5 per cent warrants appropriate priority in policy responses," the RBI review said.

Taking into account the current indication of global and domestic situation, "current rate hike would enable us to realise the inflation target of 5-5.6 per cent," Dr Reddy said.

According to the policy, "Developments during the first quarter of 2006-07 indicate that money supply, deposit and credit growth are running well above the indicative projections, warranting caution by all concerned in this regard."

"Monetary policy may not be unidirectional. Global economy and financial markets are changing swiftly. As far as global developments are concerned, we should be prepared to move in either direction in the longer term," Dr Reddy said.

The RBI will continue to ensure that appropriate liquidity is maintained in the system so that all genuine requirements of credit are met.

The RBI proposes to do this through open market operations (OMO) including Market Stabilisation Scheme, Liquidity Adjustment Facility and Cash Reserve Ratio, the review said.

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