RBI set to raise banks’ reserve requirements

RBI set to raise banks’ reserve requirements

Forecast: 24 of 25 economists expect 50 bps increase in the cash reserve ratio (CRR) , or the proportion of deposits banks must keep with the central bank. That would take the level to 5.5%.

Eight of 25 expect a 25 bps increase in reverse repo and repo rates to 5.0% and 3.5% respectively. Others expect no change in rates at the policy review.

The reverse repo rate is the borrowing rate of the central bank and is the operational rate now. The repo is the lending rate.

Factors to watch: Inflation has surged, primarily driven by a sharp rise in food prices after a weak monsoon. Signs of economic recovery are also evident in strong GDP and industrial output data.

The RBI says the rise in inflation driven by food prices is a supply-side issue monetary policy cannot address. Still, it is worried about inflation pressures spilling over to the broader economy, and will watch for signs of demand-side price pressures in indicators such as asset prices, credit growth, and manufacturing prices.

The widely watched wholesale price index rose in December by 7.3% over a year earlier, its fastest pace since November 2008 and jumping from 4.8% in November.

Food prices rose 16.81% in the 12 months to 9 January, easing from a rise of nearly 20% in early December.

Market impact: A 25 to 50 basis point increase in the CRR has been factored into bond prices. The benchmark bond yield was at 7.53% on Wednesday afternoon, up 27 basis points since end-November. It had hit a 15-month high of 7.81% earlier this month.

As the RBI meeting draws closer, some dealers are hedging their event risk by factoring in a 25 basis point increase in interest rates.

However, the market is not prepared for a very sharp rate rise and any increase of more than 25 basis points could trigger a sharp sell-off.

Such a move may also hurt shares of banks and interest rate sensitive sectors such as auto, and real estate.

The rupee is likely to fall if there is a knee-jerk slide in the stock market if both rates and CRR are increased, but traders expect the longer-term outlook to be bullish for the rupee.