RBI may not alter reverse repo rate

Policy could suggest further hardening of interest rates.

The Reserve Bank of India (RBI) may not tinker with the reverse repo rate in the forthcoming annual policy. The policy could have a hawkish undertone suggesting further hardening of interest rates, according to banking sources.

The sources, however, added that global interest rate movements and the decision of the Federal Reserve on whether or not to hike the Fed rate by another 25 basis points in the forthcoming March 28 meeting, would weigh heavily on the RBI while deciding on a reverse rate repo rate revision.

Regarding the demand for a cut in cash reserve ratio (CRR), RBI feels the liquidity gap of Rs 1,00,000 crore projected by chairmen of public sector banks during their meeting with the finance minister last week is "quite exaggerated".

The RBI is of the opinion that the liquidity situation is set to improve in the first two quarters of 2006-07. At an internal meeting at RBI last week, it has been estimated that a total of Rs 50,000-60,000 crore would flow into the system through coupon redemptions and government security maturity.

The funds mopped up through auctions of treasury bills and bonds under the market stabilisation scheme (MSS) will continue to enter the system as well. Further, the foreign exchange inflows into the Indian equity market are likely to continue at current pace.

These factors will factor when the central bank considers bankers' demand for a cut in CRR. Banks maintain 5 per cent of their net demand and time liabilities with RBI as CRR.

The state and central governments together have maintained a cash balance of Rs 40,000-Rs 50,000 crore with the RBI. The money will come back to the banking system once the government spending starts to keep up with the higher budgetary allocations.

To top it all, if the CRR is slashed, it will add to further liquidity. In fact, the RBI feels that the liquidity conditions might turnaround and the system might actually see a glut.

Besides domestic liquidity, rupee liquidity generated through RBI's intervention in the foreign exchange market is also being used to support credit.

As a percentage of foreign assets, currency in circulation has gone up to 60 per cent, which according to the Tarapore committee report on capital account convertibility (CAC) should remain around 40 as an healthy indicator, said a banking source.

Currency in circulation to foreign assets ratio indicates the creation of rupee assets by buying of foreign exchange. The higher ratio indicates that there is a robust credit creation as the money is not coming back to baking system but remains in circulation.

However the concern is that the credit is in the retail sector and not in manufacturing or infrastructure area which are indicators of economic growth. Therefore, there is a concern for liquidity expansion through CRR cut and it is felt that the system should function amidst controlled and measured liquidity.