Challenged by unrelenting inflationary pressures, Reserve Bank on Tuesday announced stringent measures of hiking mandatory cash reserve of the banks and its short-term lending rate to them to suck up an estimated Rs 20,000 crore -- a move that could make loans dearer for housing, car and personal expenses as also to the industry.

The announcement of hiking cash reserve ratio by 50 basis points and the short-term lending (repo) rate by a similar margin comes close on the heels of RBI Governor Y V Reddy discussing with Prime Minister Manmohan Singh and Finance Minister P Chidambaram the prevailing inflation scenario.

Reflecting the Finance Ministry's view that monetary policy would be the first line of defence against inflation that has surged to a 13-year high of 11.05 per cent, the RBI after intense consultation today pronounced the new measures, part of which would be effected in installments.

In a precursor to raising the CRR from 8.25 per cent to 8.75 per cent in two installments beginning July 5 and the repo rate from 8.0 per cent to 8.5 per cent with immediate effect, Reddy had said on Monday that the apex bank would do every thing to ease the inflationary pressures.

Expressing concern over rising inflation, RBI said, "Besides oil prices there are some underlying inflationary pressures impacting inflation in India."

The Reserve Bank said the move is "somewhat painful" but timely contraction of money supply has to be viewed in the context of new reality of high and volatile energy prices, which is not a temporary phenomenon any longer.

Justifying the move, the central bank said, "It is important to ensure that generalised instability does not develop and erodes the hard earned gains in terms of both outcomes and positive sentiments on India's growth momentum."

RBI's decision will have an impact on interest rates on various loans as is evident from bankers' reactions. Commenting on the impact of RBI's step, PNB Chairman K C Chakrabarty said prime lending rate could go up by 50 basis points. "All the loans linked to PLR like consumer loans, home loans, personal loans are bound to go up. At the same time, deposit rates would also be increased."

HDFC [Get Quote] Managing Director Keki Mistry said," if the cost of funding goes up, we will pass on costs to our borrowers."
However, IBA Chairman MBN Rao said banks would wait for sometime before increasing home loans. According to United Bank CMD P K Gupta, banks may have to go in for a hike in interest rates even before the monetary policy, scheduled for next month. However, the quantum of increase will be decided after assessing the situation and the need of the individual bank.

UCO Bank [Get Quote] CMD S K Goel said it does not mean increase in rates across the board. "We can adjust our short-term loans by half a per cent."

According to Indian Bank [Get Quote] Chairman M S Sundara Rajan, "We have to look at the PLR next. The bank is likely to take a decision on first week of July. Accordingly, deposit rates would also be hiked."

Industry chambers fear RBI's step may also harm India's economic growth, particularly manufacturing sector. Ficci said the move would affect the manufacturing sector, which is already facing slackening due to high interest rates. This would also affect overall rate of growth of the economy.

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