Mumbai: Intensifying its war against inflation, the Reserve Bank of India (RBI) on Tuesday increased banks’ reserve requirement, or the balance they need to keep with it, for the second time in less than two weeks, but left its key policy rates unchanged, fuelling speculation of a coming further tightening.
In its annual monetary policy, the Indian central bank raised the cash reserve ratio (CRR) by a quarter percentage point to 8.25%, effective 24 May, the highest since 2001.
This will limit the ability of banks to lend more and will help contain inflation as the raise is expected to suck out more than Rs9,250 crore from the banking system.
The increase in CRR comes a day before the Federal Open Market Committee, the policymaking body of the US Federal Reserve, is expected to cut its key policy rate by a quarter percentage point to 2%. The Fed has pared its policy rate from 5.25% to 2.25% since September 2007, but RBI has not followed suit. Even though it has not raised its key policy rate since April 2007, RBI has been tightening banks’ cash reserves continuously to soak up liquidity that stokes inflation.
On A Tight Leash (Graphic)
The decision to leave key rates unchanged cheered both capital and bond markets.
Sensex, the benchmark index of the Bombay Stock Exchange, rose 362.50 points, or 2.13%, to close at 17,378.46. Bankex, an index of banking stocks, rose 1.68%. State Bank of India, the country’s largest lender, was the biggest gainer as its stock rallied 3.27% to close at Rs1,793.50.
Bond prices across maturities rallied and the benchmark 10-year bond yield fell to 7.94% from its previous close of 8.14%.
The latest CRR hike might compel public sector banks to reverse their decision to cut down their lending rates by 50 basis points in February to boost credit growth. However, most bankers say they will wait and watch before taking any call on rates.
A basis point is one-hundredth of a percentage point.
“We recognize there are too many uncertainties,” said RBI governor Yaga Venugopal Reddy, after releasing the policy. Too many global uncertainties have happened together to bring in an “extraordinary degree of uncertainties”, he said.
Despite this, RBI forecast India’s economic growth at 8-8.5% in fiscal 2009. It also raised its inflation target to 5.5% from its earlier level of 5%, “with a preference to bringing it close to 5% as soon as possible”.
Announcing his last annual policy before his retirement in September, Reddy hinted at further increases in rates. RBI will continue to proactively manage liquidity through “appropriate use of the CRR stipulations and open market operations…using all the policy instruments at its disposal flexibly, as and when the situation warrants”, he said.
Bankers are not committing to any rate increase at this po-int. “It is left to individual ba-nks whether they want to hike their interest rate or not. Even if they do, it would be a marginal rate hike,” said M.B.N. Rao, chairman and managing director of Canara Bank.
Chanda Kochhar, joint managing director and chief financial officer of ICICI Bank Ltd, the country’s largest private sector lender, said there is no sign of money becoming dearer as yet and the bank will keep a close watch on the market rates before taking any decision on lending rates.
Punjab National Bank chairman K.C. Chakrabarty said there might not be any rate hike soon. “We have to analyse the impact of the decision before we take any step in terms of interest rates. Overall, the liquidity is good in the system and it’s (CRR) a marginal hike anyway,” said M.D. Mallya, chairman and managing director of Bank of Maharashtra.
Romesh Sobti, managing director and chief executive, IndusInd Bank, however, indicated that some banks might have to increase interest rates. “Banks, of course, bear the burden and would need to take a call on whether, and how much, of this burden needs to be passed on to borrowers. I suspect they would push lending rates marginally to retain margins,” Sobti said.
Adesh Gupta, whole-time director and chief financial officer of Aditya Birla Nuvo, the holding company of the Aditya Birla Group’s telecom and financial services businesses, however, said there could be a marginal drop in interest rate as RBI has left its policy rates unchanged. The group that plans to raise around Rs700 crore this year is not worried as its chairman Kumarmangalam Birla himself will invest Rs4,000 crore to increase his stake in Aditya Birla Nuvo in the next 18 months.
The central bank should ease the external commercial borrowings route and allow companies to raise money overseas, Gupta suggested.
Some bank economists were pleasantly surprised by the minimalism of the policy, but said these liquidity curbs were unlikely to check inflation.
Robert Prior-Wandesforde, India economist, HSBC Group Plc., said RBI’s ability to influence wholesale price inflation “is extremely limited, with international commodity prices and domestic harvests (being) the most important drivers”.
Saumitra Chaudhuri, a member of the Prime Minister’s economic advisory council, said inflation would remain high for some time to come.
“The stock markets seem to either not understand or have a tendency to dismiss the effects of this severe inflation, which according to them hurts only the poor people,” Chaudhuri said.
Chaudhuri, as well as Rajeev Malik, executive director, JPMorgan Chase, believe inflation could stay around 7%—or even just beyond that—in the months ahead, and additional fiscal measures could be necessary, including a decision on fuel prices which are kept artificially low in India.
Prior-Wandesforde expects inflation to climb to 8% later this year and remain at those levels for some months.
“In our view, the policy suggests a tightening bias will continue in the near term. The reduction in broad money growth will entail more tightening, possibly through further CRR hikes,” said Tushar Poddar, vice-president, Asia economic research of Goldman Sachs (India) Securities Pvt. Ltd.
Paromita Shastri in New Delhi contributed to this story.