Mumbai, Jan. 31: Reserve Bank of India (RBI) governor Yaga Venugopal Reddy today raised the repo rate — a key short-term lending rate at which it provides liquidity to banks — by 25 basis points to 7.50 per cent, to tame inflationary expectations as well as check high money and credit growth.

Reddy, however, left other key rates untouched so as not to hurt the growth momentum. The RBI also raised the GDP growth forecast to 8.5-9 per cent for 2006-07 from the earlier estimate of 8 per cent.

RBI’s Third Quarter Review of Annual Statement of Monetary Policy did contain an element of surprise, something which is now regular with Reddy.

While most in the financial community believed he would raise both the reverse repo — rate at which RBI absorbs liquidity against securities — and the repo rate by 25 basis points each, he only altered the repo rate.

For a banking system, that is already grappling with relatively low liquidity after the half per cent rise in cash reserve ratio, Reddy’s decision to raise the repo rate means that if a bank approaches the RBI for funds, the central bank will lend it at a higher rate.

There were few important reasons that led the central bank to take this measure. “At this point in time, the conduct of monetary policy is confronted with three important issues. First, demand pressures appear to have intensified, reflected in rising inflation, high money and credit growth, elevated asset prices ... Second, there are increased supply side pressures in evidence from prices of primary articles. Third, monetary policy will have to contend with the lagged response of productive capacity and infrastructure to the ongoing expansion in investment,” Reddy said in his policy statement.

Faced with these challenges, the central bank took three critical measures. It increased interest rates (repo) to assuage demand pressures. To tackle the issue of high credit growth that could erode the quality of credit thereby affecting the balance sheets of banks, RBI increased the provisioning and risk weights in specific sectors.

The RBI also referred to another problem, rising inflows into non-resident deposit schemes. To modulate these flows so as to ensure effective liquidity management and at the same time curb instances of large growth in advances being granted against such deposits, the central bank brought down the interest rate ceilings on FCNR (B) and NR(E) RA deposits.

Speaking to newspersons later, Reddy tried to put things in perspective when he said that at this juncture, “it is important to bring inflation to the range that was indicated earlier”. The RBI projected inflation to be between 5.0-5.5 per cent for the period ending March 31, 2007, while recent figures have shown it to be around the 6 per cent mark.

According to the central bank, while prices of primary food articles continue to remain firm, prices of manufactured products have also shown upward movement.

On the other hand, demand pressures have been building up as reflected in increasing consumption and investment demand. Moreover, asset prices appears to have risen.

“Overall the impact of these developments on inflation expectations, in general, warrant a determined policy response by all concerned to quell such adverse developments for several critical reasons,” the RBI said.