Interest rate on housing, vehicle and other consumer loans is likely to shoot up further, with Reserve Bank of India on Friday raising key short-term lending rate (repo*) by a quarter per cent as also increasing mandatory deposits by banks by 0.5 per cent to contain inflation.
Ahead of its annual monetary policy scheduled next month, the RBI in a sudden move hiked the repo rate and Cash Reserve Ratio** to 7.75 per cent and 6.5 per cent, respectively to suck out about Rs 19,500 crore (Rs 195 billion0 from the system.
The RBI move is a part of the stated policy by Finance Minister P Chidambaram that the government and apex bank would continue to take appropriate fiscal and monetary measures to control inflation, which is hovering at a high of 6.46 per cent.
The hike in repo rate means that commercial banks would have to pay more to borrow from the central bank and the move is aimed at tempering the high demand for retail loans, particularly in the housing sector.
Also, the 0.5 per cent hike in CRR, the amount of depositors money that banks have to park with RBI, would leave banks with little for lending activities.
The decisions would also lead to hike in interest rates on deposits, which is a cheap source for banks to mobilize funds.
State Bank of India deputy managing director Arun Sandilya said the decision would hit profitability of banks and would force it to review rates.
"The RBI are the final arbitrators on interest rates. But given the rising inflation, it is natural interference that there may be tightening of monetary policy," Finance Minister P Chidambaram had said on Thursday.
Asian Development Bank, in its report early this week, had forecast that tightening of monetary policies to tackle overheating would slow down the country's economic growth to 8 per cent in 2007-08.
RBI said the hike in Cash Reserve Ratio would be implemented in two phases, with the first instalment of 0.25 per cent scheduled to happen from April 14 and the second from April 28.
The CRR will go up to 6.5 per cent after the hike.
*Repo rate is the rate at which the central bank borrows money.
**CRR is the statutory reserve that has to be maintained by banks either in cash or as balance with the Reserve Bank of India. CRR is intended to be a reserve by which the RBI assures itself that the bank is safe and has the liquidity for servicing its depositors.
Bank Rate is the minimum rate at which the Reserve Bank of India will make short-term advances (usually for overnight) to the banks.