Mumbai / New Delhi: After a series of fiscal measures by the Indian government failed to contain the rising inflation, the Reserve Bank of India joined the fight by raising banks’ cash reserve ratio (CRR), or the amount of cash that banks are required to maintain with the Indian central bank, by half a percentage point in two stages to 8%.
Despite the surprise hike late Thursday evening, many bankers and bond dealers said they don’t think the Indian central bank is through with its measures. Some of them said that they suspect RBI could still go for a rate hike when it announces the annual monetary policy on 29 April.
WHY RBI ACTED (Graphic)
The latest CRR hike will take out Rs18,500 crore in liquidity from the banking system and make credit dearer. None of the banks, however, claim they will raise their lending rates immediately.
“We will wait till the monetary policy is announced before we take any decision on rate hikes,” said M.B.N Rao, chairman of Canara Bank. Rao also heads the Indian Banks’ Association, the country’s premier bankers body.
Several bankers said they are certain that this will dampen credit growth, which has already slowed down considerably. The credit growth of India’s banking system has dropped to a four-year low in 2007-08.
The year-end data for bank credit, released by RBI last week, showed bank credit for fiscal 2008 grew at 21.6% or Rs4.17 trillion, sharply lower than the 27.6% in 2007.
Vijay Mehta, vice-chairman of publicly traded auto component manufacturer Clutch Auto Ltd, said the move will hurt manufacturers. “The impact will be felt more by smaller manufacturers than the organized players across the country,” he said.
The two-stage CRR hike will come into effect on 26 April and 10 May. With this, RBI has now raised CRR by full three percentage points since December 2006.
The Indian central bank has not raised its key policy rate since April 2007 but it has been using CRR frequently to tighten the monetary policy.
“There has been increasing pressure on RBI to act fast as inflation has been rising. We are not very sure whether it is through with the measures as yet,” said Nitin Jain, head of ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds.
The wholesale price-based inflation, which was 3.83% during the time of RBI’s third-quarter policy review in January, increased to 7.41% in March-end and is 7.14% in April. “... Overall impact on inflation expectations requires to be monitored and moderated,” RBI said.
“The inflation numbers are just too high,” says Abheek Barua, chief economist of HDFC Bank Ltd.
“The governor has been talking about the correspondence between the inflation and expectations. So, we have been anticipating some interim action before the actual policy review. In fact, we expect the governor to follow this up with a repo rate hike during the policy review on April 29.”
Some analysts say this will hurt industrial expansion, already at a four-and-half-year low.
Said Ajay Shah, senior fellow, National Institute of Public Finance and Policy: “In India, monetary policy transmissions don’t work very well. The CRR hike, essentially a quantitative restriction, will just decrease the efficiency of the banking system. A more effective move would have been to let the rupee appreciate.”
Does this mean that the economy will now have to learn to live with lower growth?
Saumitra Chaudhuri, economic adviser with rating agency Icra Ltd and member of the Prime Minister’s economic advisory council, says he doesn’t think so.
“The CRR hike was very necessary,” he said. “This will mean that inflationery expectations will now get delinked from growth. The economy is growing at a very good pace. If this means a 8.5% or even 8% growth this year, that is still very good.”
Indeed, the strained capacity utilization figures in almost every sector of manufacturing is the most important indicator of rapidly rising demand pressures.
Central power utilities have produced 9,200MW last year, compared to their past average of 4,700MW. It is the same story in cement.
“The supply-side bottlenecks are only in those areas where the government is involved. Elsewhere, it’s a question of expectations created by straining capacity use,” Chaudhuri adds.
Indranil Pan, chief economist Kotak Mahindra Bank Ltd, does not think that banks will rush to hike their lending rates immediately.
“A half-a-percentage point hike in CRR is in line with our expectations...I don’t think it will have an immediate impact on the interest rate.”
M.D. Mallya, chairman and managing director of Bank of Maharashtra, said the CRR hike was expected. “By sucking out the excess liquidity, the prevailing inflation can be moderated,” he said.
Prakash Mallya, chairman of Bangalore-based Vijaya Bank, said some of the banks that have cut down their lending rates might have to roll back their decision.
A string of public sector banks cut their lending rates in February after finance minister P. Chidambaram said they should pare their rates to fuel credit growth.
P.S. Subramaniam, a banking analyst at SBI Capital Markets Ltd, said bank stocks will be hit as the profit margins will be impacted by the RBI measure.
“This will definitely be negative for the stock markets, especially for the banking stocks and other interest rate sensitive stocks such as automobile and real estate,” he said.
Apurva Shah, head of equity research at domestic brokerage Prabhudas Lilladher Pvt. Ltd, too, said that there will be a negative impact on the stock market. Indian stock markets are closed on Friday and will reopen for trading on Monday.
Nesil Staney contributed to this story.