The Reserve Bank of India has raised its short-term lending and borrowing rates with immediate effect during the mid-quarterly review of the monetary policy. While the repo or lending rate was hiked by 25 basis points to 6%, the reverse repo or borrowing rate was increased by 50 basis points to 5%. This is the fifth instance of rate hike by the central bank this year.

“I think it (the rate hike) is in the right direction because now the corridor has been narrowed down and still inflationary pressure is there in the system,” Finance Minister Pranab Mukherjee told media persons in New Delhi today. “I think the adjustment of repo and reverse repo will help to mop up additional liquidity, which is putting pressure on the system,” he added.

Montek Singh Ahluwalia, deputy chairman of the Planning Commission said that the rate hike will not impact foreign portfolio inflows into the country.

The latest rate hike is expected to result in an increase in cost of funds for banks. This will ultimately make loans more expensive, thereby reducing consumption. Chief economic advisor Kaushik Basu said that the banks may increase deposit rates, but the liquidity adjustment facility (LAF) corridor signals them to lower the gap between loans and deposit rates. He added that the RBI move is not to dampen growth prospects and future hikes cannot be ruled out.

The RBI move is specifically meant to tame inflation, though the inflation has displayed a tendency to mellow. The central bank has pointed out that inflation has reached a plateau, but is likely to remain at unacceptably high levels for some more months. While the overall inflation came down in the last two months, food inflation is climbing up once again.

The RBI move aided in ending the stock market’s dream run this week. Sensex closed 0.43% lower at 19,417.

The Commonwealth Bank of Australia’s first Indian branch started functioning in Mumbai, thus making it the first Australian bank to acquire full banking license in the country. A statement from the bank said that the Mumbai branch will focus on trade finance, remittances and foreign exchange services for businesses involved in bilateral trade between the two nations. The Mumbai branch will have staff strength of 28, headed by CEO Ravi Kushan.

“We have chosen India as one of our preferred growth markets along with China, Indonesia and Vietnam. We are increasingly looking at emerging markets. But links to Australia are important for us,” Simon Blair, group executive, international financial services, CBA said.

“By establishing a branch in Mumbai, the Bank is committed to facilitate economic, trade and payment flows. The full-fledged banking presence puts the Bank in a strong position to continue to explore growth opportunities in India,” Mr. Blair added.

“We are starting to work with Indian companies which are looking at investments in Australia. Moreover as 52% of people of Indian origin in Australia bank with us, we see a lot of opportunities in the area of remittances and NRI banking services,” said Ravi Kushan, CEO, Mumbai branch of CBA. Australian banks are venturing out to Asian countries due to the diminishing opportunities back home.

CBA, which figures among the top 21 banks in the world, started its India operations in 2004 in Bangalore by offering trade finance services to local businesses having trade links with Australia. The Australian bank may expand its Indian operations depending on how the governmental regulations turn out.

The recent spat between Sebi and Irda over ULIPs had raised the question of governmental supervision in their activities. However, Finance Minister Pranab Mukherjee clarified that government has no intention do so; various regulatory agencies such as RBI, Sebi and Irda would continue to enjoy autonomy. The FM was addressing media at the conclusion of the meeting with chief ministers of the southern states and heads of public sector banks in Hyderabad on Tuesday.

Mr. Mukherjee said that government would step in only if there is a conflict between regulators regarding the jurisdiction of hybrid products like ULIPs. He said that government would pass an ordinance to introduce a joint mechanism to earmark the jurisdiction of conflicting regulators. “Except this, there will be no interference by the government,” he added.

The finance minister called for increase in advances by banks to micro, small and medium enterprises (MSME) sector. He said that banks should work towards achieving the target of raising their share of advances to the sector to 50% by the end of the current fiscal and 55% by next, as this is a vital part of the financial inclusion program. He said banks should also chip in by ensuring smooth credit flows to sectors such as housing, education and weaker and minority sections.

The minister also commented on the current woe of Indian economy, namely, inflation. He said until May, food items contributed mostly to inflation; food price inflation almost touching 20% at the fag end of last year. Though food prices have come down to below 15% now, inflation has become broad-based and is rising due to fuel prices and other components.

With the economy on the upswing post-recession, Indian banks are riding high due to increase in demand for loans and decrease in bad loans. This is expected to show up in the first quarterly results.

The country’s leading lenders, State Bank of India, ICICI Bank and HDFC Bank are witnessing a steady climb in demand for loan over the past few months. Another positive phenomenon seen is the drop in the number of loan defaulters, resulting in improvement in the quality of assets. With the economy predicted to grow beyond the government forecast of 8.5% in the current fiscal, there is a definite surge in confidence level all around.

The intermittent rate hikes by the Reserve Bank of India to combat the spiraling inflation has largely left this feel-good atmosphere untouched. The imminent RBI policy review scheduled for July 27 may also see another marginal rate hike, without any impact on the loan demand.

One of the reasons attributed to this is the presence of ample liquidity in the system. The rate hikes are too small to have any effect on the system. Moreover, the amazing growth of the economy is opening up lucrative avenues for the banking sector. The first quarter also witnessed the unbelievable competition among telecom providers in securing the 3G spectrum and their subsequent clamber to cough up adequate money to pay the spectrum fees to the government.

The superb performance of the manufacturing sector in the last few months has led to a substantial reduction in bad loans and defaulters. The first quarter of the current fiscal saw a drop of 30 basis points in the 10-year benchmark bond yield, which is beneficial from bank’s perspective.

The annual bank credit stands now at 21.7%, which is a tremendous improvement from 9.7% last October.