RBI bites the bullet by increasing both repo and reverse repo by 25 BPS

Reserve Bank of India on Thursday in its Mid-quarter review increased the repo rate, the rate at which RBI lends to banks and reverse repo rate, the rate at which banks lend to (or rate at which banks keep excess amount with) RBI by 25 basis point (1 basis point is hundredth of 1 percentage) each.

Repo rate is increased from 6.5% to 6.75 and reverse repo rate is increased from 5.5% to 5.75% with immediate effect.

This move from RBI was expected due consistent high inflation was worrying the government and central banker. Even though high inflation was mainly due to higher price of basic food articles, some analysts believe that higher food price was spilling over to the other parts of the economy causing manufacturing and wage inflation.

But the move was not easy for the RBI as it is following worries...

1. In this financial year RBI has increased the rates 7 times before this

2. Consistent low IIP numbers in recent months

3. Middle east crisis causing oil spike leading to increase in commodity prices which intern may replicate downgrading of the earnings and ultimately slowing down the economy from recovery mode.

RBI has also mentioned the following points in its observation...

"Continuing uncertainty about energy and commodity prices may vitiate the investment climate, posing a threat to the current growth trajectory. In particular, the weak performance of capital goods in the IIP suggests that investment momentum may be slowing down"

"The March 2011 WPI inflation is now revised its estimation to around 8 per cent from earlier forecast of 7%"

"While the budgeted level of fiscal deficit for 2011-12 gives some comfort on the demand front, a potential increase in the subsidies on petroleum products and fertilizers as a result of high crude prices could put pressure on expenditure. It is critical, therefore, to focus on the quality of expenditure, keeping the aggregate under control without compromising on the delivery of services. Only by doing this can the fiscal situation contribute to demand-side inflation management."

"CAD (Current Account Deficit) for 2010-11 is now estimated to come lower than earlier expected, at around 2.5 per cent of GDP"

"The policy action in this Review is expected to:

• continue to rein in demand-side inflationary pressures while minimising risks to growth; and

• manage inflationary expectations and contain the spillover of food and commodity prices into more generalised inflation."