Bankers see interest rate hike signal

RUN UP TO THE CREDIT POLICY

Bankers feel time is not ripe for rate increase as the banking system is awash in liquidity.

The yield on the benchmark 10-year government paper, a barometer of interest rates, has gone up by around 50-60 basis points (one basis point is one hundredth of a percentage point) over the last one month. The yield on the 10-year paper is currently hovering at 7.10 per cent, up from 6.60 per cent in March.

The wholesale price index-based inflation, too, has inched up from under 5 per cent to 5.48 per cent for the week ended April 9. Inflation is expected to rise further once petroleum product prices are raised. Since last year, inflation had been rising and fell below 5 per cent (to 4.83 per cent) for the first time in 40 weeks for the week ended February 19, 2005.

Against this backdrop, will Reserve Bank of India (RBI) Governor YV Reddy signal a hike in interest rates when he unveils the annual credit policy on April 28? Senior bankers feel the time is not yet ripe for the RBI governor to take such a call as the banking system is awash in liquidity.

Moreover, Finance Minister P Chidambaram has clearly said the interest rates will be stable during the coming six months. Yet there may be a signal on an impending rate hike by the RBI in its policy document, bankers point out.

The reverse repo rate (the rate at which the central bank sucks out funds in exchange for securities) was last raised in October 2004 by 0.25 per cent to 4.75 per cent. In the same month, the cash reserve ratio (the cash balance that banks have to maintain with the RBI) was hiked by 0.50 per cent to 5 per cent, thereby draining out

Rs 7,000 crore to Rs 8,000 crore from the system.

The bank rate (the rate at which RBI offers refinance to banks) was last tinkered with two years back in April 2003 when it was reduced by 0.25 per cent to 6 per cent, a three-decade low.

"A hike in the rate at this juncture will spoil the investment party. Reddy will possibly wait before biting the bullet," said an industry observer.

But interest rates have been firming up globally. The US Federal Reserve has raised the benchmark overnight lending rate seven times since June 2004 -- by 25 basis points each to 2.75 per cent. The US Fed has indicated that it will raise interest rates at a "measured pace" in a pre-emptive effort to fight inflation.

In India, there is surplus liquidity of Rs 60,000-70,000 crore (between the repo-reverse market and market stabilisation bonds), easing the pressure on interest rates. This is despite the abnormally high credit growth rate of 30 per cent. Total bank credit surged by Rs 266,849 crore to a total outstanding figure of Rs 11,41,701 crore in 2004-05.

The two factors that hold the key to interest rates were crude oil prices and the monsoon, analysts said. Crude prices have come down to $50 a barrel after touching a high of $57 in late March. If it goes up again and the monsoon is less than normal, interest rates are bound to go up. For the time being, Reddy may just issue a caution on interest rates and not actually hike them.