Leading economists expect the Reserve Bank of India (RBI) to desist from tightening key short-term rates by more than 0.25 percentage points at its quarterly monetary policy review on Tuesday, give the slowdown in industrial output and poor credit offtake.
The RBI will conduct its second quarter monetary policy review on Tuesday (November 2). Bankers, markets and the industry have already resigned themselves to the possibility of a 0.25 per cent hike in the short-term lending rate (repo) and borrowing rate (reverse repo).
So far this year, the RBI has raised these rates by as much as 1.25 per cent over the course of five consecutive monetary policy meetings. In addition, it effected a single hike of the cash reserve ratio (CRR), the quantum of deposits that lenders are required to part with the central bank in cash.
Most recently, it had increased the repo and reverse repo rates by 0.25 and 0.50 percentage points, respectively, on September 16 to 6 and 5 per cent to tame inflation. However, it had left the CRR, bank rate unchanged at 6 per cent each and the statutory liquidity ratio, too, at 25 per cent.
While the central bank's prime concern is to curb stubborn inflationary pressures, economists have argued that the RBI will not be oblivious to the three key challenges before it -- an ebbing growth trend, poor credit offtake and uncomfortably high inflation.
Headline inflation stood at 8.6 per cent in August, while food inflation was a high 13.75 per cent in the week ended October 16.
Another major concern is the tight liquidity situation following the massive Rs 15,500 crore Coal India public float last week and high festive spending by consumers ahead of the Diwali festival later next week.
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The very tight liquidity conditions also led to call money rates hitting historic highs and CPs touching 20-year highs last week.
In fact, the liquidity situation was so bad that the RBI opened a second LAF (liquidity adjust facility) window yesterday and brought down the SLR by 1 per cent to 24 per cent for two days. Yesterday, the banks borrowed a whopping Rs 1.31 lakh crore from the central bank.
Leading global financial services firm E&Y India's National Leader for Global Financial Services, Ashvin Parekh, is of the firm opinion that Reserve Bank Governor Duvvuri Subbarao will only go in for a 25 basis points hike -- with one basis point equal to one-hundredth of a percentage point hike in key policy rates -- to 6 and 5 per cent respectively, while the CRR will be left unchanged at 6 per cent.
"It (the policy action) will be a 25 bps hike. I believe so primarily on two counts: for the past two months, credit offtake has been very poor. Therefore, another hike will force corporates to look at corporate bonds to raise money or other sources.
"Secondly, the latest IIP numbers and core sector growth rates have been very discouraging. But having said so, the governor will respond to another to respond to the high inflation; hence, a 25 bps spike is on the way," Parekh argued.
It can be noted that factory production numbers (IIP) for August nosedived to a 15-month low of 5.6 per cent, while core sector output fell to an 18-month low of 2.5 per cent in September.
Another key deterrent to an excessive rate hike is the steady rise of the rupee due to large forex inflows, says Parekh.
Since September, the rupee has risen by nearly 6 per cent on the back of foreign fund inflows worth $11.7 billion into domestic stocks. Since the beginning of this year, FIIs have pumped in a record $25 billion into the country on the back of dirt cheap interest rates in their home markets and the high returns from emerging markets like India.
Parekh further explained that even during the crisis period, credit growth was between 20 per cent and 25 per cent. But now, it was much lower, at around 18 per cent. "If there is higher industrial activity, there has to be a cumulative growth in credit offtake too. Every 1 per cent rise in GDP should translate into a 3-4 per cent increase in credit growth," he concluded.
Fitch Ratings India Director D K Pant, too, was certain "the Governor will effect a 25 bps tightening in the policy rates to tame inflation. I don't expect a harsher action as RBI will have to factor in the ebbing growth rates and the easing demand for credit".
Edelweiss Capital President Rujan Panjwani also feels the repo and reverse repo rates will be hiked by 25 bps and did not see any change in the CRR rate, as inflation has become a difficult animal to tame.
However, he added, "There is no consensus in the market as such as most people are a bit confused looking at the larger picture of trailing growth rates and the rising rupee."
He went on to say, "There is no urgent need to spike the rates, as the 2007 business and investment confidence levels are yet to come back to the country."
"The biggest reason for not hiking the rates is the large forex inflows and the concurrent appreciation of the rupee," Panjwani said.
On the street expectations from the November 2 policy review, he said markets have already factored in a 25 bps increase. "There will be a hike, because doing so next year will be harder. So my sense is that there is a 50:50 chance of a moderate hike on Tuesday," he said.