Mumbai: After a pause in December, the Reserve Bank of India (RBI) on Tuesday once again raised its key policy rates by 25 basis points (bps) each to make money more expensive and contain rising inflation in the world’s second fastest growing major economy, even as it cautioned banks to moderate their loan growth.
The latest round of hikes, the seventh this fiscal, will take the repo and reverse repo rates, or the rates at which the central bank lends and accepts funds from banks, to 6.5% and 5.5%, respectively.
Graphic: Yogesh Kumar/Mint
Analysts and economists expect further hikes in the next few months as inflation continues to be a risk to the economy and far higher than the central bank’s annual projection. RBI, in fact, has raised its baseline Wholesale Price Index-based inflation projection for the fiscal ending March to 7% from 5.5%.
The average inflation rate in the first nine months of this fiscal has been 9.4%.
Despite the rate hike, bond prices rallied and the yield on the most-traded 11-year paper fell to 8.20% by the end of trading on Tuesday, from 8.24% before the policy announcement. Bond prices and yield move in opposite directions.
Bond dealers said the market is happy as RBI has made clear its intentions that any rate hike will be gradual and the outlook is clear.
The equity market, however, did not cheer the policy. The Bombay Stock Exchange’s benchmark Sensex index ended down 0.95%, after rising immediately when the policy was announced.
The 14-share Bankex, an index of bank stocks, closed 2.34% down, with ICICI Bank Ltd, the largest private sector lender, losing the most at 4.1%.
RBI has kept its projection for growth in 2011 unchanged at 8.5% with an “upward bias”, but showed concerns about keeping the growth momentum next year because of high inflation, a large current account deficit and the lack of fiscal consolidation by the government. Analysts attributed the fall in the stock market to these concerns.
Bankers acknowledged that RBI’s move had confirmed an upward bias in rates, but ruled out any immediate hike in loan rates.
“Immediately, a small (policy) rate hike like this may not lead to a (loan) rate hike, but there is clearly an upward bias in rates,” said O.P. Bhatt, chairman of State Bank of India, the nation’s largest lender.
Chanda Kochhar, managing director and chief executive officer of ICICI Bank, said there is need to watch whether deposit growth catches up with credit growth.
Loan rates will rise
RBI governor D. Subbarao, however, expects loan rates to rise following the policy rate hike.
“If the monetary policy transmission works as we hope, rates will go up and banks will have to hike their rates,” he said.
Indian banking industry’s deposit growth has been 16.5% in the past one year while the loan book has grown 24.4%, against the central bank’s projection of 20%. RBI wants banks to go slow on loan growth and this could be done if it makes money more expensive.
Most banks have raised their loan rates in December and January. They have also been raising their deposit rates.
Hemant Mishr, managing director and global head of markets at Standard Chartered Bank in India, expects a 50 bps hike in policy rates in the next three to four months.
“We factor in a further hike of 75 bps in the repo rate during 2011, with a renewed front-loading bias,” Barclays Capital economists Siddhartha Sanyal and Kumar Rachapudi said in a note.
Leif Lybecker Eskesen, chief economist for India and Asean at HSBC Global Research, Singapore, said an additional 100 bps “are on the cards by end-2011, with the next hike just around the corner and likely coming as soon as March”.
Goldman Sachs economists Tushar Poddar and Vishal Vaibhaw also echoed the sentiment. “We expect the next hike to be in mid-March, and continue to maintain our view of a cumulative 100 bps hikes in 2011,” they said.
According to analysts, RBI’s concerns about high credit growth, rather than the rate hike, was behind the fall of bank stocks.
“Banks need to focus on the underlying structural cause of liquidity tightness arising out of the gap between the credit and deposit growth rates,” RBI said in its policy statement.
At the post-policy press meet, Subbarao said, “Credit growth should moderate to curb the unnecessarily build up of demand.”
Banks should focus on increasing their deposits and they have to contain their credit growth while the central bank will monitor the banks “on our supervisory responsibility to ensure those banks that are far out of line are in line”, he said.
Granting bankers’ demand for liquidity support, the central bank also extended additional liquidity facility to the extent of 1% of deposits till 8 April. Roughly this translates into Rs 50,000 crore. The special liquidity window was to close on 28 January.
Cash-starved banks were borrowing as much as Rs 1.5 trillion daily on some days in December. This has come down since then. Under this arrangement, banks offer government bonds as collateral and raise ultra short-term money from RBI to take care of their temporary asset-liability mismatches.
Subbarao warned that even as RBI will endeavour to give liquidity to the banks, “there is a limit of how much the Reserve Bank can do... We have to strike a balance”.
Similarly, there is also a limit to what extent RBI alone can manage inflation. Subbarao made it clear that the government should address structural issues and focus on fiscal correction as a measure to contain inflation, as persistent high food and oil inflation spills over to general inflation.
According to RBI, the government needs to bring down its fiscal deficit as otherwise it will crowd out private demand. To bridge its fiscal deficit, the government borrows from the market and high government borrowing may make it difficult for private firms to raise funds from the market. In the current fiscal, the government is borrowing Rs 4.61 trillion.
While the “crowding out” threat was a theoretical possibility, now it is becoming a “more and more a distinct possibility”, Subbarao said.