Red flags price rise, current account and fiscal situation as possible risks that could impact economic expansion.
While RBI retained its GDP growth projection at 8.5 per cent for 2010-11 with an upside bias, the policy action factors in the possible emergence of risks that could impact economic expansion.
“We have highlighted risks, and those risks have to do with what is emerging as a somewhat unstable macroeconomic environment, which is the inflation situation, the current account situation and the fiscal situation. Those are not base-line scenarios, but point out some risks that are becoming visible that may affect growth,” RBI Deputy Governor Subir Gokarn told Business Standard.
Inflation continued to be the apex bank’s main concern. “The stance of the monetary policy is to contain the spill-over of high food and fuel inflation into generalised inflation and anchor inflationary expectations, while being prepared to respond to any further build-up of inflationary pressures,” RBI stated in its third-quarter review of monetary policy.
| HIGHLIGHTS |
| * Repo rate hiked by 25 bps to 6.5% |
| * Reverse repo up by 25 bps to 5.5% |
| * Inflation target up from 5.5% to 7% |
| * FY11 GDP growth retained at 8.5% |
Market participants said RBI’s role in controlling inflation was limited to containing the collateral damage arising out of high food and fuel prices. “The 25-bp increase may be too meek to impact inflation. But if inflation were to persist, another hike is inevitable” said Madan Sabnavis, chief economist, Care Ratings.(Click for graph)
“The actual action has to be seen in the context of the stance. The stance is hawkish; the stance is that inflation is a dominant concern, but the action is related to the specific circumstances that we are dealing with today. That is, there is some build up of demand-side pressure, which we see in non-food manufacturing inflation and a stronger action at this point might have put some pressure on growth, which we are trying to avoid,” Gokarn said.
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The central bank also red flagged the high incremental credit-deposit ratio, which is at 102 per cent for the banking industry. “The message is exactly as we put out. We told banks that they must increase their deposits and they must restrain their credit. And the credit growth and the deposit growth have to be aligned. Additionally, we also said that we would monitor this very closely and use our supervisory responsibilities to ensure that those banks, which are far out of line, are brought in line,” said RBI Governor D Subbarao at a press briefing after the policy review announcement.
Markets were none-too-pleased by Mint Road’s action. The Bombay Stock Exchange Sensex shed almost 1 per cent amid concerns that banks would have to offer higher deposit rates in the fourth quarter to garner funds and maintain their credit-deposit ratio to address the regulator’s disquiet. This could dent their margins. The BSE Bankex was the day’s biggest sectoral loser at 2.34 per cent.
ICICI Bank stock fell by nearly 4 per cent to Rs 1,041.30 on the BSE. Shares of IndusInd Bank, HDFC Bank and Kotak Mahindra Bank lost 2-3 per cent. Most public sector bank stocks shed less than 1 per cent.
After hiking policy rates six times in the current financial year until November, RBI had taken a pause. It left rates unchanged in the mid-quarter review in December. However, the central bank is now expected to resume rate hikes to tackle rising prices, economists said.
“We are front-loading our rate-hike call. From 75-bp rate hikes between Q3 FY11 and Q1 FY12 earlier, we now expect a 25-bp rate hike in March, followed by another 50 bps in H1 FY12,” stated a report by Sonal Verma and Ketaki Sharma, economists with Nomura Securities.
Market participants now expect policy rate hikes of 25 bps in the March and May policy reviews.
According to bankers, who met RBI brass at a post-review meeting, the regulator wants to ensure that banks do not use daily borrowed funds to support credit growth. Credit growth at 24.4 per cent has lagged RBI’s projection of deposit growth. Now, the central bank says it is important that credit growth moderates to 20 per cent to conform broadly to indicative projections.
Bankers ruled out any immediate hike in their own interest rates, though they said there was an upward bias. “This is small hike. It may not necessarily translate into an immediate interest rate hike. We have seen that monetary policy transmission happens with a lag,” said O P Bhatt, chairman of State Bank of India, the country’s largest lender.