RBI Policy Review - RBI raises policy rates; guides for a softer stance:: Edelweiss

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The Reserve Bank of India (RBI), lifted both the repo rate and reverse repo rates by 25bps to 6.25% and 5.25% respectively, thereby maintaining the LAF corridor at 100bps. The CRR was left unchanged, as expected. Although, the overall action was more aggressive than expected, the accompanying statement was much milder, with RBI acknowledging that “likelihood of further rate hike in immediate future is low”. Containing inflation and anchoring inflation expectations without hurting growth was the key motivation behind the policy move. The objective of ensuring financial stability also played on the minds of policymakers. The central banks imposed stringent norms on housing loans by commercial banks such as increasing the risk weights, higher provisioning for teaser rate loans, among others. 

On liquidity front, the objective of RBI is to keep the conditions broadly in balance - not too loose to impair policy transmission but not so tight as to hurt the economic growth. With government spending, the central bank expects the current liquidity deifcit situation to improve. Meanwhile, the central bank left unchanged the FY11 real GDP growth forecast at 8.5%, WPI inflation projection at 5.5% and credit growth projection at 20%.

With this move, we believe that policy rates have reached neutral zone- neither too restricve nor too accomodative for economic growth and the past actions taken should soften inflation further towards RBI’s comfort zone. Therefore, going ahead, we expect a pause in RBI’s interest rate tightening cycle. The domestic growth is consolidating around sustainable levels but the policymakers are mindful of risks amenating from weaker growth in advanced economies. The risk to the outlook mainly arisis from upward pressure on domestic inflation if the global commodity prices continue to inch higher on account of fresh monetary stimulus in advanced economies.