In a surprise move Governor Raghuram Rajan during the RBI policy review hiked the repo rate by 25 bps and left the cash reserve ratio (CRR) unchanged.
Read Rajan's full speech:
Good morning and welcome to the Reserve Bank.
Today, on the basis of an assessment of the current and evolving macroeconomic situation, we have decided to increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 8.0 per cent.
2. Let me first address the balance of risks that confronts us in the evolving macroeconomic outlook. The slowdown in the economy is getting increasingly worrisome. Our current assessment is that growth is likely to lose momentum in Q3 of 2013-14, with industrial activity in contractionary mode, mainly on account of manufacturing. Lead indicators of services also suggest a subdued outlook, barring some pick-up in transport and communication activity. On the other hand, agricultural performance has so far been robust, and the strong pick-up in rabi sowing indicates that this should be sustained.
3. Another silver lining is the significant narrowing of the trade deficit on the back of resilient export growth. The current account deficit for 2013-14 is now expected to be below 2.5 per cent of GDP as compared with 4.8 per cent in 2012-13. The recent resumption of capital inflows should help finance the current account deficit comfortably. Reserves have been rebuilt since September, and are expected to increase further as oil marketing companies, that have been buying foreign exchange in the market, repay the Reserve Bank when their swaps come due. Nevertheless, given the uncertain external environment, the government and the RBI cannot pause in their efforts to ensure fiscal and monetary stability.
4. The gravest risk to the value of the rupee is from CPI inflation which remains elevated at close to double digits, despite the anticipated disinflation in vegetable and fruit prices. Moreover, inflation excluding food and fuel has also been high, especially in respect of services, indicative of wage pressures and other second round effects. Elevated levels of inflation erode household budgets and constrict the purchasing power of consumers. This, in turn, discourages investment and weakens growth. High inflation weakens the rupee. Inflation is also a tax that is grossly inequitable, falling hardest on the very poor. It is only by bringing