Home, auto and corporate loans are likely to become expensive, with the RBI raising key short-term lending and borrowing rates by 0.25 and 0.50 percentage points, respectively, to combat inflation.

In its maiden mid-quarterly monetary policy review on Thursday, the central bank upped repo, under which it lends short-term funds to banks, to six percent and reverse repo, the short-term borrowing mechanism, to five percent.

The hike in the policy rates, the fifth this year, to cool inflation that is hovering at 8.5 percent may lead to an increase in commercial lending and deposit rates.

“In early October, interest rates could be revised and chances are there it could be revised upwards,” state-run Bank of Baroda’s Executive Director R K Bakshi said.

Bankers said they will hold on to the rates till 30th September, which is the half yearly closing of the banks.

High interest rates could temper demand for loans and thus curtail consumption, while on the other hand fixed deposits could earn better returns.

The government expects inflation to cool to six percent by December.

“Rate of interest may have to go up. Pressure is there to increase rates in the near term,” Bank of Maharashtra CMD Allen Pereira said.

Short-term funds would get little costlier and there is possibility that the short-term (deposit) rates could also go up in the future, bankers said.

Central Bank of India CMD S Sridhar said, “Bankers will adopt a calibrated approach. The examination of interest rates is on cards as cost of funds for banks is increasing.”

However, a few bankers ruled out increase from 1st October as they will wait for further policy action of RBI.

“EMIs are not going to go up from October 1. The quarter percentage increase in policy rates were expected. Further rate hikes by bank will depend on the next policy review,” HDFC Chief Executive Keki Mistry said.

He said a further increase in rate in the second quarter review in November could lead to higher rates.

Following an identical hike in repo and reverse repo rates in July, 40 banks raised deposit rates and 29 lending rates.

The RBI too wants deposit rates to go up as there is a need to make the real interest rates, the difference between inflation and deposit rate, positive. “…real interest rates need to move in the direction of encouraging bank deposits”, the central bank said.

Industry chamber Ficci also expressed the fear that rising interest rates would hit business.

“Increasing repo rate is another signal of rising the cost of borrowing…hopefully it is the last such… restrictive action towards growth. We hope to see this restrictive policy eased in the next round”, said Ficci secretary general Amit Mitra.

Expressing concern over the RBI move, PHD Chamber said, “This will adversely impact the cost of borrowing by the industry from the banks, especially by the SMEs. It may also the cost of home loan as well as consumer loans.”

For RBI the major concern in inflation as “headline inflation remains significantly above the trend of 5.0-5.5 per cent in the 2000s.

“I think it (the RBI move) is in the right direction because now the corridor (difference between repo and reverse repo) has been narrowed down and still inflationary pressure is there in the system,” Finance Minister Pranab Mukherjee told reporters in New Delhi on Thursday.

The 100 basis points gap between repo and reverse repo marks the return to the pre global financial meltdown level.

Planning Commission Deputy Chairman Montek Singh Ahluwalia said: “This (hike) is in the right direction and on the expected lines. This is not going to affect the economic growth.”

Government data last month showed that the economy grew by an impressive 8.8 percent in the April-June quarter, driven by a robust manufacturing sector.

However, the central bank wondered if the industrial expansion data was reflecting the reality.

“Although the year-on-year growth rate for the first four months of the year remains robust at 11.4 per cent, the high volatility over the past two months raises some doubts about how effectively the index reflects the underlying momentum in the industrial sector,” RBI said.

The data on the Index of Industrial Production (IIP) showed that industrial growth accelerated to 13.8 percent in July from 7.2 percent a year ago, belying all expectations of slowdown.

RBI described the data as volatile since the previous month it was just 7.1 percent, which was further revised down to 5.6 percent, analysts said.