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RBI Hikes Repo Rate

While a hike in interest rates is necessary to combat inflation, corporate India is already faced with slowing growth which higher interest rates will further hinder

Inflation is proving to be a nuisance. And, with the price of crude refusing to get lower, it appears that we will have to live with it for a while. Meanwhile, the central bank, the Reserve Bank of India (RBI), is doing all it can to control the beast.

The year-on-year WPI inflation which was 4.36% on January 12, 2008 (at the time of announcement of the Third Quarter Review for 2007-08) increased to 7.33% on April 12, 2008 (at the time of announcement of the Annual Policy.

Statement for 2008-09). It then moved to a high of 8.24% on May 24, 2008. Further, various measures of CPI inflation, which ranged from 4.8% to 5.9% in January 2008 have increased to a range of 7.8% to 8.9% in April 2008.

Accordingly, yesterday the RBI has decided to increase the repo rate under the Liquidity Adjustment Facility (LAF) by 25 basis points to 8.00% from 7.75% with immediate effect. There is no change in the reverse repo rate and the CRR. Though the markets were expecting some monetary tightening from the central bank, the rate hike may prove to be another nail in the coffin for the bulls. Banking, auto and real estate shares will be the worst hit. Others like infrastructure and capital goods may also fall further.

Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.