Money supply to be tightened further

Increase in CRR seen just for starters.

The Reserve Bank of India's (RBI's) decision yesterday to raise the cash reserve ratio (CRR) to 5 per per cent may not have an immediate impact on interest rates, but bankers said in the medium term, rates would harden as credit had started picking up.

This is the first monetary measure to combat the rising rate of inflation, which is now at a four-year high of 8.33 per cent.

Earlier, the government had tried to contain inflation through fiscal measures like reducing the Customs duty on steel and the excise duty on crude oil prices.

The market believes that the CRR hike is the first in a series of tightening measures the RBI is expected to announce over the next few months.

Till recently, RBI Governor YV Reddy had refrained from any tightening measure as the rise in the rate of inflation was largely perceived to be on account of rising oil import costs. Inflation was not driven by demand, went the reasoning.

A banking industry source said the RBI had been reluctant to raise the CRR, but had been under pressure from the finance ministry to do so even though no move was being contemplated to hike interest rates.

Even though RBI insiders insisted that the hike in the CRR was a temporary measure and the decision might be reversed once the rate of inflation was under control, senior bankers said this could be the prelude to a tight money policy.

The last time the CRR was hiked was in August 2000, when former RBI Governor Bimal Jalan raised it from 8.25 per cent to 8.5 per cent to contain volatility in the foreign exchange market.

The 50 basis point hike, which will suck out Rs 8,500 crore from the system, will come into play in two stages, the first a 25 basis point rise on September 18 to 4.75 per cent, and the second on October 2 to 5 per cent.

The tightening of liquidity through the hike in the CRR is seen as an admission that the current bout of inflation is also on account of rising money supply and not solely a fallout of rising oil prices.

Bankers do not expect any immediate impact on lending rates though credit has started picking up.

"There is ample liquidity in the system, well in excess of Rs 40,000 crore. We don't see any immediate rate hike," said SBI Chairman AK Purwar.

Banks will, however, be impacted by the RBI decision to cut the interest rate on the CRR drastically, from 6 per cent to 3.5 per cent.

In Reddy's first monetary policy of 2002-03, he said the RBI would continue to pursue its medium-term objective of reducing the CRR to its statutory minimum of 3 per cent, while retaining the option to use the CRR in both directions for liquidity management in addition to other instruments.