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Bonds and stocks rose after he raised the two key policy rates—reverse repo and repo—by 25 basis points each, and left banks with Rs 12,500 crore less to lend with a 25 bps increase in the cash reserve ratio (CRR). The Street, which was betting on a 50-bps hike, felt the governor was taking a risk with inflation and may have to aggressively raise rates in future. “It’s present gain, but future pain,” quipped a bond trader. 

But for Mr Subbarao, who did not rule out another rate hike before the July monetary policy, it is like crossing a river by feeling the stones. “There are two ways to look at this. One, as David Lloyd George said, ‘You cannot cross a chasm in two leaps’. The other is Deng Xiaoping’s ‘crossing a river by feeling the stones’. We chose to feel the stones. This time it looks like we will move several times,” he told reporters.
For high-street banks, it was a measured move that will not trigger an increase in lending rates. “I don’t see an immediate increase in interest rates, but there could be some pressure in the second quarter,” said ICICI Bank CEO Chanda Kochhar. Mortgage leader HDFC also said it would not raise home loan rates in the ‘near term’.
But most bankers think RBI will have to raise rates as well as increase CRR in small doses during the year. Banks borrow from RBI at the repo rate while parking (or lending) surplus funds at the reverse repo rate. The repo and reverse repo rates are 5.25% and 3.75%, respectively. CRR, which is like a tax on lenders, is the slice of customer deposit that banks have to set aside as cash with RBI. After the 25 bps CRR hike, from 5.75% to 6%, banks will have Rs 12,500 crore less to lend from the fortnight beginning April 24.
But even as it makes borrowing more expensive and mops up extra cash from the system to rein inflation, the central bank will have to keep enough money for the government to borrow. “RBI will have to intervene and carry out open market operations, and in a way CRR hike was a preemptive step...It will not want the market to move from a reverse repo to a repo mode,” said Indranil Sen Gupta, chief economist (India), Bank of America Merrill Lynch, which in a prepolicy note said RBI could hike the rates and CRR by a quarter point each. If loan growth and 3G auction payout lowers liquidity, banks will have to borrow at repo if RBI does not step in to create liquidity. And once the market is in a repo mode, rising bond yields will make government bond auctions difficult and expensive. An overarching factor that has made RBI’s job tougher is the Rs 91,000 crore of extra bonds that the government will sell this year.
RBI began tightening in January when it raised the CRR by 50 bps in two stages. This was followed by the 25 bps increase in repo and reverse repo in March.
While RBI has been slower than its counterparts in Australia and Israel in raising rates, it has been quicker in reversing the cycle than the Chinese central bank and monetary authorities in many advanced economies.

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