In a bid to strengthen the rupee, Reserve Bank of India Governor Raghuram Rajan raised the key repo rate on Tuesday (Jan 28th, 2014), the third time since the September of last year when Mr. Rajan had taken over as the governor. And the Indian currency has already shown a sharp recovery since the policy announcement.
However this meant that he made a choice to confound expectations in order to renew focus on inflation. Mr. Rajan is of the view that the value of the rupee faces a major risk from the CPI (consumer price index) inflation, which is already elevated at close to double digits, despite the predicted disinflation in vegetable and fruit prices. He also claimed that the main target of the RBI is that they want to bring the inflation down so that it will present them with some room on the monetary front which could then be passed on.
The repo rate, which is the rate at which banks borrow short-term money from the RBI, was raised by 25 basis points, i.e. 0.25 percentage point, to 8 percent. The reverse repo, the rate at which the RBI borrows from banks, was raised 25 basis points to 7 percent. And in order to maintain the balance, the marginal standing facility, the penal rate of interest for banks was raised 25 basis points to 9 percent, while the cash reserve ratio was maintained at the initial 4 percent.
David Walker, Executive Director, SARE Homes shared his view on this change, “The repo rate increase is designed to reduce India’s persistently high inflation and also provide support to the currency. This will adversely affect demand in the short term, which is of concern given the slowdown in growth, but is required to for price stability which brings with it higher medium to long-term consumption and investment”.