Reddy goes all out to rein in inflation

Reddy goes all out to rein in inflation
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First Published: Wed, Jul 30 2008. 12 29 AM IST

Updated: Wed, Jul 30 2008. 12 29 AM IST
Mumbai: Loans will become more expensive for companies and individuals with the Reserve Bank of India, or RBI, raising a key interest rate for the third time in less than two months to curb the rising inflation, which is at a 13-year high. The Indian central bank also raised the cash reserve ratio (CRR), which defines the balance commercial banks need to keep with it.
On Tuesday, the central bank increased the policy rate by 50 basis points and CRR by 25 basis points. One basis point is one-hundredth of a percentage point.
With the latest round of increases, both CRR and the repo rate, or the rate at which RBI infuses liquidity in the system (or lends money to banks), are at 9%.
The hike in CRR will limit the ability of banks to lend more, and help contain inflation as the raise, effective 30 August, will suck out around Rs9,000 crore from the banking system. Banks will likely increase their lending as well as deposit rates from Wednesday and the quantum of hike could be as much as 100 basis points for some banks.
Policy signals: RBI governor Y.V. Reddy.
RBI’s aggressive stance had an impact on both bond and equity markets. The yield on 10-year benchmark government bonds, at 9.05% on Monday, rose to 9.54% after the policy announcement. Prices and yields on government bonds move in opposite directions.
Investors rushed to sell bank stocks and other rate-sensitive stocks such as those of real estate firms, pulling down India’s bellwether equity index Sensex 3.89% or 557.5 points to 13,791.54 on Tuesday’s trade.
The Bombay Stock Exchange’s banking index was down around 8.3%, the worst among all sectoral indices. Shares of ICICI Bank Ltd and HDFC Bank Ltd lost around 8.5% each and those of State Bank of India, 7%. And shares of India’s largest realtor DLF Ltd lost 5.52% and those of Unitech Ltd, 6.5% even as BSE’s realty index dropped 5.54%.
Sanjeev Prasad, co-head institutional securities at Kotak Securities Ltd, said there is limited downside to bank, real estate and automobile stocks as their valuations are down significantly.
Not many analysts, however, share his view and most have found the policy “more hawkish than expected” with some saying that the central bank has gone for “overkill”. RBI governor Y.V. Reddy now has raised the key interest rate by 125 basis points and CRR by 175 basis points this year to fight rising inflation.
In the quarterly review of monetary policy, unveiled on Tuesday, Reddy dropped enough hints that the central bank is not yet through with its rate hike cycle and implied that it has “headroom” to use its policy tools. In sync with the rate hike, the central bank has pared the projection for India’s gross domestic product (GDP) growth from 8-8.5% announced in April to 8% now.
Economists said even this target could be difficult to achieve if the rates are hiked again in future. “The growth story will definitely be hampered. We will revise our growth outlook from the present 7.5%,” said Shubhada Rao, chief economist, Yes Bank Ltd.
Subir Gokarn, chief economist, Standard and Poor’s Asia-Pacific, said: “A trade-off between growth and inflation in the current circumstances is inevitable. Despite the clear signs that growth is slowing, as seen in the recent industrial production numbers, it is far too early for RBI to move to a neutral position, let alone reverse course. Even after all that has been done, inflationary pressures may still be aggravated by global developments.”
“This is a pre-emptive measure taken by RBI to de-risk the economy. It is a clear signal that credit growth should slow down. But, overall, the growth rate won’t be below 7.5%.” said Indranil Pan, chief economist, Kotak Mahindra Bank Ltd.
Despite the monetary tightening, RBI will not be able to bring down inflation to its projected level of 5-5.5%. It has, in fact, raised the year-end inflation projection to 7% although it wants to bring down the “current intolerable inflation” to below 5% “as soon as possible” and around 3% in the “medium term”.
Industry lobbies such as Confederation of Indian Industry, or CII, and the Federation of Indian Chambers of Commerce and Industry, or Ficci, are not too happy with the RBI stance. According to CII, the central bank could have waited to see the lag effects of the last round of monetary actions in June 2008 before taking further steps. “Increase in interest rates could impact the investment momentum and corporate cash flows. The future trends in corporate profitability and execution of the investment pipeline would need to be monitored in this context,” a CII release said. Ficci, too, feels the RBI action will dent business confidence.
Since many companies have embarked on huge capacity expansion plans, the impact of capital becoming dearer, “will affect corporate profitability as a whole”, said Hitesh Agrawal, head of equity research at Angel Securities Ltd, a Mumbai-based brokerage.
According to Prabal Banerji, chief financial officer of the diversified Hinduja Group, firms will find it very difficult to raise funds as money will be really scarce, and the cost of borrowing will go up substantially.
All Indian banks raised their lending rates after RBI’s 24 June hike in interest rate and CRR and will likely go for another rate hike soon. K.C. Chakrabarty, chairman and managing director, Punjab National Bank, said the bank would increase interest rates in the next few days.
Officials at the country’s oldest mortgage lender Housing Development Finance Corp. Ltd did not comment on the impact of RBI’s move but said the cost of funds would go up, clearly indicating that the mortgage rates will rise. HDFC chairman Deepak Parekh had earlier said a decision on interest rate would be taken after RBI’s review.
“The central bank is giving a clear indication to banks to hike interest rates,” said Meera Sanyal, executive vice-president and country executive, India, ABN Amro Bank.
Prakash Mallya, chairman and managing director, Vijaya Bank, added that banks will have to increase their lending rates to protect their net interest margin.
Chanda Kochhar, joint managing director of country’s largest private sector lender ICICI Bank, said: “The interest rate structure of the banking system (is) going through a dynamic review and adjusting to the evolving market realities,” hinting at an imminent rate hike.
The finance ministry said RBI’s decision to hike short-term lending rate and mandatory deposit requirements were a signal to banks to moderate credit growth.
“Government expects that the measures taken by RBI, in continuation of the measures already taken over the last two months, will help in moderating and containing inflation,” a finance ministry statement said here.
The quarterly review statement harped on the rising “demand pressure” and RBI’s concerns about “strong credit growth” of some banks. It has even threatened to check the books of select banks which have been aggressively lending.
Asking banks to focus on quality of credit and avoid piling up stressed assets as well as asset-liability mismatches, the RBI statement said, “If necessary, the Reserve Bank would consider undertaking supervisory review of those select banks which are over extended in terms of their credit portfolios relative to their sources of funds.”
Despite a series of hikes in policy rates this year, the credit growth of banks up to 4 July is 25.9% on a year-on-year basis, well above the central bank’s growth projection of 20%. India’s former finance minister and Bharatiya Janata Party member Yashwant Sinha said the policy was “a hammer blow” and the “surest prescription for slowing down the economy”.
Anup Roy, Nesil Staney and Ankur Relia contributed to this story.
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First Published: Wed, Jul 30 2008. 12 29 AM IST