RBI Governor D Subbarao says ‘baby steps’ better for economy
In a bid to tackle rising inflation, the Reserve Bank of India (RBI) today raised policy rates for the second time in as many months and also announced an increase in the cash reserve ratio (CRR) to squeeze out excess liquidity from the system.
In its Annual Policy Statement for 2010-11, the central bank raised the repo and reverse repo rates by 25 basis points each, effective today. CRR will also go up by 25 basis points, but from Friday.
Repo is the rate at which banks borrow from RBI, while reverse repo is used to drain excess cash lying with the banks. An increase in policy rates signals a rise in interest rates, while CRR is used to manage liquidity. The CRR increase will take away Rs 12,500 crore from the system.
While some economists said the central bank might have to raise rates again before the first quarter review that is scheduled for July 27, RBI Governor D Subbarao said he would not like to take mid-policy action. He, however, did not hide his concern over rising inflation. Subbarao has projected that inflation based on the wholesale price index (WPI) would moderate at around 5.5 per cent by March next year, compared with 9.9 per cent last month.
“We believe that taking several baby steps towards normalisation is better for the economy to adjust with the pre-crisis growth level,” Subbarao said.
Bankers said RBI’s twin moves are unlikely to affect lending rates immediately.
“Lending rates may not be changed in the near future. Margins may come under pressure,” said HDFC Bank Managing Director Aditya Puri.
Other bankers added that rates were likely to remain stable during the current quarter, given the liquidity in the system.
“We will still be able to meet 20 per cent credit growth, given 17 per cent growth in deposits, the liquidity available in the system and the government borrowings. In the first six months, liquidity will be there in the system. Going forward, rates will go up,” said Union Bank of India Chairman and Managing Director M V Nair, who also heads the Indian Banks’ Association.
State Bank of India (SBI) Chairman O P Bhatt said there would be an upward bias but any decision on rates would depend on the demand and supply in the system. “In any case, we can’t have a situation when we are priced out of the market,” he added.
On March 19, RBI had announced a 25-basis points increase in the policy rates after inflation based on WPI had crossed the central bank’s estimate of 8.5 per cent. In January, RBI had raised CRR by 75 basis points.
Apart from India, Australia and Malaysia have also raised borrowing costs, while last week Singapore announced it would allow its currency to strengthen.
While RBI was widely expected to increase policy rates and CRR, the small dose of increase surprised the market. The stock markets drew comfort from the action and this was reflected in the Bombay Stock Exchange's benchmark index, the Sensex, which closed with a gain of 0.34 per cent at 17,461 points.
The bond market also showed similar sentiments, with the yield on the benchmark 10-year government paper easing 10 basis points to close at 7.98 per cent.
Subbarao cited rising cost of oil as one of the three risks that may fuel inflation, along with monsoon rains and evidence of demand-side pressures building up. He was, however, bullish on growth and estimated that the Indian economy would expand by 8 per cent or more as against 7.2 per cent estimated for 2009-10.
The governor said it was important to calibrate the exit, given the revival in demand for credit and the large government borrowing programme. Credit flow is expected to grow by 20 per cent this year.
Apart from reining in inflation, the regulator also announced a slew of reform moves, ranging from a review of the mode of presence of foreign banks in India to setting up of bank holding companies.
| VOICES Lending rates may not be changed in the near future. Margins may come under pressure — Aditya Puri, MD, HDFC Bank During the year, interest rates are going to go up. There is an upward bias but no immediate impact. Credit demand will pick up in the second quarter and that’s when rates may go up — Chanda Kochhar, MD&CEO, ICICI Bank There will be an upward bias but it (rates) will depend on the demand and supply in the system — OP Bhatt, Chairman, SBI |
In addition, RBI laid bare its intention to issue new bank licences and a plan to allow establishment of new urban co-operative banks.
Further, it initiated steps for the development of the corporate bond and derivatives markets. In case of derivatives, norms for credit default swaps, which help banks hedge their credit risk, would be announced soon, RBI said. It also decided to allow options trading in currency.
In a note, Citi India economists Rohini Malkani and Anushka Shah said there was a possibility of an inter-policy hike and a further 75 basis point increase was likely in 2010.
“The relief is likely to prove temporary, however, as an intra-meeting hike is likely, which in turn will be followed by several more steps in our view. We continue to expect a total of 200 basis points of repo and reverse repo rate hikes by mid-2011,” HSBC Global Research said in a note.
