Does Reddy have any choice but to hike the rates? At best he can delay it. In his last annual credit policy for fiscal year 2006, Reserve Bank of India Governor Y V Reddy had fixed the target for the inflation rate in the range of 5-5.5 per cent. Consistent with this, the projected expansion of money supply (M3) was 14.5 per cent. Finally, in tune with this money supply growth, the rise in banking system's deposit liability was set at Rs 2,60,000 crore or 15 per cent, and the non-food credit was projected to increase by 19 per cent. On all these four counts, the RBI projections have gone wide off the mark.
The money supply growth as on March 24 was 16.5 per cent. Despite that, the RBI has been able to contain the average inflation rate for the year at a little over 4 per cent, much below its target. The deposit growth as on March 17 has been Rs 3,03,577 crore or 17.9 per cent, while the non-food credit grew by Rs 3,41,458 crore, about 32 per cent. But for the sudden tightness of liquidity in the last quarter on account of over Rs 30,000 crore India Millennium Deposit (MD) outflow, it has by and large been yet another year characterised by price stability, "appropriate liquidity" meeting credit demand and maintenance of the growth momentum. Indeed, the interest rate scenario has shown an upward bias. It could have had a sharper northward move had the Central Bank not bought about the $9 billion from the foreign exchange market (and release an equivalent amount of rupee liquidity in the system) and redeemed Rs 17,050 crore of Market Stabilisation Scheme (MSS) in the January-March quarter.
Two key issues that Reddy is widely perceived to be addressing in his credit policy next week are liquidity and interest rates. The banking system was up in arms last month demanding a cut in their cash reserve ratio (CRR), which is 5 per cent now and can go down to 3 per cent. A one percentage point cut in CRR at this point can release about Rs 20,000 crore into the system. One indicator of liquidity is the RBI's repo and reverse repo windows. The Central bank sucks out excess liquidity at 5.5 per cent through its reverse repo window and infuses money into the system at 6.5 per cent through the repo window. Between March 20 and March 25, the daily average infusion of money through the RBI's repo window was over Rs 20,000 crore. The trend has reversed. On April 10, the RBI sucked out Rs 49,860 crore from the system. On April 7, the quantum was Rs 32,715 crore and April 5, Rs 29,990 crore. So, one can safely presume that Reddy will not be in a hurry to cut the CRR.
What will be his stance on the rate front? Will he hike the key short-term rates "" repo and reverse repo "" or even the bank rate to signal his policy preference? The last time the RBI raised interest rates was in January (by 25 basis points). Between October 2004 and January 2006, it had raised the reverse repo rate by 1 percentage point "" from 4.5 per cent to 5.5 per cent. Over the past one year, reverse repo rate has been hiked by 75 basis points (one basis point is one hundredth of a percentage point) and repo rate by 50 basis points (from 6 per cent to 6.5 per cent) but the key signalling device bank rate has remained unchanged at 6 per cent.
The US Federal Reserve has hiked the Fed funds rate over the past one year by 2 percentage points "" from 2.75 per cent to 4.75 per cent. It is expected to push it up to 5 per cent at the next Federal Open Markets Committee (FOMC) meeting, and may not even stop there. During this period, the European Central Bank has hiked its rate by 50 basis points (2 per cent to 2.5 per cent); Bank of Canada 125 basis points (2.5 per cent to 3.75 per cent); and Reserve Bank of New Zealand 50 basis points (6.75 per cent to 7.25 per cent). Bank of England, on the other hand, has cut its key rate by 25 basis points over the last one year (from 4.75 per cent to 4.5 per cent) while Reserve Bank of Australia has kept the rate unchanged at 5.5 per cent. So, there is no uniform trend about the interest stance taken by the global central banks.
In many ways, the RBI's dilemma is unique. The finance ministry is keen that the momentum of growth is sustained and to achieve this, it is imperative that growth in bank credit must not be slackened. The credit growth last year has been about 32 per cent. This is on the top of a 30 per cent credit growth in the previous year. The incremental credit:deposit ratio is way above 100 per cent. On an outstanding basis, the credit:deposit ratio is 72 per cent. As the banks need to invest 25 per cent of their deposits in government securities in the form of statutory liquidity ratio (SLR) and 5 per cent in CRR, technically, they are left with no funds (except for their capital) to lend. The unprecedented growth in credit, expansion in money supply, and the rally in equity markets, real estate and global commodity prices can create imbalances which no central banker would love to encourage. Does Reddy have any choice but to hike the rates at this juncture? At best, he can delay it.
