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For once, govt in sync with RBI on inflation

For once, govt in sync with RBI on inflation
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First Published: Fri, Feb 29 2008. 12 33 AM IST

Updated: Fri, Feb 29 2008. 12 33 AM IST
Mumbai: The government has virtually ruled out any possibility of a cut in interest rate by the Reserve Bank of India (RBI) when it meets in April to formulate the monetary policy for 2008-09 even as banks have stared paring their lending and deposit rates.
In a rare instance of the country’s finance ministry sharing the central bank’s concerns about rising inflation, the Economic Survey, released on Thursday, has admitted that the “monetary policy needs to address the inflationary expectations.” Banking analysts see this as a clear indication that interest rates will not be cut any time soon. RBI will announce its monetary policy for the year on 29 April.
The survey has also noted that the central bank will have to “manage the stress arising from continued increase in capital flows”.
In January, RBI, in its third quarter review of the monetary policy, spoke about “potential inflationary pressures” arising from “commodity price rise, volatile oil markets and impact of likely stronger foreign exchange inflows” into emerging market economies. It also left policy rates unchanged, disappointing the market which was expecting a quarter percentage point cut in policy rates after the US Federal Reserve went for aggressive rate cuts to prop up its economy.
RBI governor Y.V. Reddy began raising interest rates in October 2004 and intensified his monetary tightening measures in 2006 to fight rising inflation, higher capital inflows and fast growing bank credit. Since January 2006, RBI has raised the repo rate, or the rate at which it injects liquidity into the financial system (or lends to banks), by 150 basis points to 7.75%. During this period, the reverse repo rate, or the rate at which RBI sucks out liquidity from the system (or borrows from banks), has been raised by 75 basis points to 6%.
It has also raised the cash reserve ratio, or CRR (which defines the amount of money commercial banks have to keep with the Indian central bank), by 250 basis points to 7.5% since December 2006.
A. Prasanna, vice-president, ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds, said the Economic Survey “has confirmed that RBI will not cut interest rates in the near term.” According to him, the bond market is prepared for this and there has been a sell-off in the government bond market over the last two weeks, given the bearish sentiment on inflation. The yield on benchmark 10-year government bonds rose from 7.44% to 7.70% over the last fortnight.
Wholesale price index-based inflation in India was 4.35% for the week ended 9 February and economists expect it to rise to 4.6-4.7% in mid-February. This is below RBI’s comfort zone of 5%, but much higher than the 3.8% seen in the first week of January.
Indranil Pan, chief economist at Kotak Mahindra Bank Ltd, said that many people “believed that the finance ministry was putting pressure on the central bank to reduce interest rates, but the Economic Survey does not support that. In fact, the survey suggests that while the supply side bottlenecks on account of agriculture or infrastructure development could be taken up by the government, inflationary pressures are best tackled by RBI.”
There are, however, others who still say that there is scope for a rate cut by RBI. Robin Roy, associate director at PricewaterhouseCoopers Pvt. Ltd, a tax consultancy and audit firm, said there are enough “theoretical” reasons for an interest rate cut such as a slowdown in credit growth. The Economic Survey notes that the central bank had visualized expansion in the non-food credit during 2007-08 by around 24-25% compared with 28% a year ago, but commercial banks’ credit actually grew by only 22% till the first week of January. “There are pressures on both, the finance ministry and RBI, to encourage a softer interest rate regime, 2009 being a year of general elections. The possibilities of a rate cut cannot be ruled out altogether.” Roy added.
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First Published: Fri, Feb 29 2008. 12 33 AM IST