Mumbai: The Reserve Bank today wiped out any hopes of interest rates easing in the near future, as it hiked the CRR - the amount of money banks must hold in cash - by 0.5% to suck out liquidity despite inflation at a five-year low.
The central bank, however, kept key lending and borrowing rates (repo and reverse repo rates) and bank rate unchanged in the mid-term review of annual monetary policy.
Cash Reserve Ratio is the amount of cash banks need to park with RBI, which does not pay any interest on such deposits.
Unveiling the busy season monetary policy, RBI Governor Y V Reddy sent strong signals that the apex bank’s hawkish stance would continue in order to ensure price stability, credit quality and orderly conditions in the financial market.
Flush with funds, commercial banks have been reducing deposit rates to bring down cost of funds and slashing rates on new retail loans to improve credit offtake. This had raised hopes of interest rates falling further, although bankers maintained there would be no change in the rate regime.
ICICI joint managing director Chanda Kochhar said the CRR hike will stabilize liquidity and “further hike in interest rates is unlikely.”
The central bank left the economic growth projection for 2007-08 unchanged at 8.5% and continued to focus on keeping inflation low.
Though inflation has come down to 3.07%, RBI expected it to be in the vicinity of 5% by the end of 2007-08. Going forward, it resolved to contain inflation expectations in the range of 4-4.5% so that an inflation rate of around 3% becomes a medium term objective.
Between December 2006 and July 2007, RBI had raised CRR by 2 percentage points to 7% and sucked out about Rs56,000 crore from the financial system.
Highlighting several challenges facing the conduct of monetary policy, RBI said management of capital flows, related liquidity implications and overall stability were biggest challenges on the domestic front.
Yet another challenge was rapid escalation in asset prices, particularly equity and real estate, driven by capital flows which are often opaque, highly leveraged and largely unregulated, the RBI observed.
“Monetary policy will have to contend with the risks to overall macroeconomic stability and threats to inflation expectations emanating from fluctuations in asset prices, the re-pricing of risks and their diffusion across the financial system,” it said.
The RBI observed that the momentum in investment has been affected by changes in the interest rate cycle and spending on capital expenditure and infrastructure has weathered the transient slack in industrial activity in the second quarter.
Key monetary aggregates like reserve money and money supply have been running well above initial projections, it said.
Asset prices remain at elevated levels although there is some anecdotal evidence of stabilising real estate prices, the RBI said.
The apex bank said equity prices were at record highs and although inflation, in terms of wholesale prices appears to have eased, remains high in terms of consumer prices.
To curb the menace of recovery agents, RBI has asked banks to prescribe to specific considerations while engaging recovery agents.