The rupee and stock markets slumped on the central bank's move.
In his first monetary policy review after taking charge at Mint Street Sep 4, RBI Governor Raghuram Rajan, however, partially rolled back the measures taken by his predecessor D. Subbarao.
The RBI increased the repurchase or repo rate by 0.25 percent to 7.5 percent. Repo rate is the what commercial banks pay when they borrow short-term money from the RBI.
The reverse repo rate or the interest rate that RBI pays to the commercial banks on their short-term deposits, is adjusted to 6.5 percent from the earlier 6.25 percent.
These are the two key policy rates that determine lending and borrowing rates by the commercial banks. The RBI move will make home, auto and other loans costlier and worsen the industrial and overall growth situation which is already sluggish.
The RBI policy announcements had a direct impact on the stocks and currency markets. The benchmark Sensex of the Bombay Stock Exchange tumbled by almost 600 points. And the Rupee slipped to 62.61 against a dollar.
Addressing a media conference after the monetary policy announcement, Rajan said the central bank had tried to strike a balance between growth and inflation.
"Priority of the central bank has always been both inflation and growth."
Agreed Planning Commission Deputy Chairman Montek Singh Ahluwalia. "I think it is a quite balanced statement actually. He (RBI Governor Rajan) has done something which will ease liquidity and at the same time try to send the signal that RBI is concerned about bringing inflation down," Ahluwalia said.
Reacting on the RBI move, State Bank of India (SBI) Chairman Pratip Chaudhuri said the lending and borrowing rates were likely to go up.
The country's largest lender had hiked the lending and term-deposit rates Thursday, a day before the RBI policy announcements.
The RBI reduced the marginal standing facility (MSF) rate by 75 basis points from 10.25 percent to 9.5 percent with immediate effect.
The central bank had hiked the marginal standing facility rate to 10.25 percent in mid-July to support the bruised rupee.
The Cash Reserve Ratio (CRR), the proportion of money that commercial banks must keep with the central bank, has been kept unchanged at 4 percent.
The minimum daily maintenance of CRR has also been reduced from 99 percent of the requirement to 95 percent effective from the fortnight beginning Sep 21, the RBI said.
The central bank's surprise move of hiking the key policy interest rate came just a few days after the government data showed a sharp jump in inflation.
The headline inflation, based on wholesale prices rose to 6.1 percent in August, the sharpest pace in six months, driven by more than 18 percent jump in food prices, according to government data released earlier this week.
"The intent here is that when the repo rate becomes the effective policy rate, it should be consistent with inflationary conditions in the economy. On net, these measures will reduce the cost of bank financing substantially while allowing us to take an appropriately precautionary stance on inflation," Rajan said.
On US Federal Reserve stimulus move that had led a sharp rally in the Indian stocks and currency, Rajan said Indian should use this temporary external relief as an opportunity to make its system "bullet proof".
"Let us remember that the postponement of tapering is only that, a postponement. We must use this time to create a bullet proof national balance sheet and growth agenda, which creates confidence in citizens and investors alike," Rajan said.
The US central bank Wednesday decided to continue with its USD 85 billion monthly bond-buying programme, known as Quantitative Easing (QE) 3. The speculation of cut in the stimulus had led a huge sell off in the Indian stock markets and depreciation in rupee.
Reacting to the RBI move, FICCI president Naina Lal Kidwai said: "The increase in the repo rate by 25 basis points has come as a surprise to us."
Kidwai said India Inc. was expecting a cut or at least a status quo in the policy interest rate and the hike in repo rate would dampen investments.
"High interest rate has been identified as a major barrier to boosting growth by various studies and surveys. Entrepreneurs are holding on to their investment plans pending any relaxation in monetary policy by the RBI," she said.
"The increase in repo rate could have been avoided as industry is already reeling under pressures of high cost of capital and low availability in a tight liquidity situation," said Confederation of Indian Industry (CII) director general Chandrajit Banerjee.
--IANS (Posted on 20-09-2013)