The RBI (Reserve Bank of India) increased the repo rate earlier this month (in 11th June; from 7.75% to 8%) - a move which was justified by India's Finance Minister P.A. Chidambaram as part of its attempts to contain rising inflation.

This aggressive move  which came exactly a week after domestic fuel prices were raised and the country's inflation reached 8.75 percent for the week ended May 31 against 8.24 percent for the week before, took everyone by surprise as the RBI had refrained from raising benchmark rates in its policy meet in April 2008. SMEs in the country were also shocked as the move came a time when they are struggling with rising raw material costs, rising fuel prices, increased cargo rate and an uncertain business outlook.

As the increase in repo rate means banks' lending getting costlier, everyone knows that it is none but the SMEs and MSMEs in the country which are going to be affected most when the repo rate is hiked. In addition to increasing the repo rate, the central bank also sucked over Rs 27,000 crore out of the economy by increasing the Cash Reserve Ratio (CRR) by 0.75 per cent in three phases.  In fact, the RBI has used CRR as a measure to fight inflation many times in the past as a result of which banks’ lending rates have rose by 5-7% in the last couple of years.

While the RBI stated that the recent repo rate hike is in line with the global trend and it has been necessitated by the changing global liquidity conditions and rising inflationary pressures, it overlooked the fact that in many European countries such as the UK, SMEs are able to raise funds through the Alternative Investment Market (AIM) while, in India, there is none but the banks to avail commercial support to SMEs. The government has recently planned for a dedicated stock exchange for small and medium enterprises (SMEs) to tap the capital market, but experts doubt success of such a venture as proposals indicate that access could be restricted to a limited investor base.      

But despite all the preventive measures by the RBI and the government, India's annual inflation rate touched a 13-year high of 11.05 percent (for the week ended June 7) leaving the whole country- the policy makers, the business community, and the general public- all speechless. The Finance Minister confirmed, "The government is aware of difficulties... Naturally, we will have to look at stronger measures on demand and monetary sides...We will try to address to best of our abilities the demand and monetary sides and try to improve supply side also".

Although Chidambaram did not elaborate on the measures, economists and bankers has warned that the government is very likely to consider further hikes in the repo rate and the cash reserve ratio (CRR), a move which  could lead to increase in lending rates. A member of Prime Minister's Economic Advisory Council has revealed , "There is lot of pressure on interest rates and the RBI may further tighten the monetary policy in order to anchor inflation to reasonable level". The RBI would come out with quarterly review of the Credit Policy on July 29, and it is possible that the central bank may increase repo rate or CRR before July policy review.  

Any change in repo or CRR by the RBI would force the banks in the country to revise both deposit and lending rates. And, if bank interest rates rise again, it is sure and certain that the SMEs in the country are going to face much more difficulties in the coming days. Industries like real estate, automobiles, consumer durables have already been hit by the bank interest rate hike in the last few years. A further hike in repo rate or CRR, even after the last one earlier this month, will certainly worsen the situation and adversely affect other industries as well.

And this time again, SMEs - unlike their larger counterparts - will be affected most as they have to rely solely upon bank credits for their financial requirements. In a country where SMEs contribute roughly 40% to the country’s total domestic production, and close to 50% of total exports, further hike in key rates may prove fatal to the economy of the country.