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Hard feelings on rates
- Inflation spurt raises compulsions of hike in cost of money as price warriors don battle gear

Mumbai/New Delhi Aug. 20: Interest rates are expected to move up soon, though the country’s largest bank says the cost of money would be steady in the short run.

State Bank of India (SBI) chairman A. K. Purwar reassured depositors and borrowers that rates at both ends will stay the way they are for a while. He did, however, concede the possibility of an increase later.

“In view of the ample liquidity in the system, interest rates are likely to stay stable in the short run despite inflationary pressure. This is true of SBI’s rates, and in fact those of the entire system. The medium and long-term trends are not so certain,” Purwar said in Mumbai when asked about the effect of a spurt in the inflation rate to 7.96 per cent.

Economists and officials believe the Reserve Bank (RBI) will have to curb inflationary pressures to stem the growing economic insecurity in people. In its policy stance for the current financial year, the central bank had promised liquidity for credit growth but had also said it would “keep a close watch on inflation”.

But, the heavy liquidity in the financial system is fast becoming unmanageable as it fans inflation, fuelled by rising fuel and commodity prices, which have tracked global trends and raised input costs for manufacturers.

That liquidity would remain manageable was one of the bases for forecasting inflation at 5 per cent during 2004-05 — a projection that also assumed no major shortfalls in basic commodities.

“Inflationary pressures in the economy reinforce the view that there will be a 25-50 basis-point repo rate hike by February,” Icra managing director P. K. Chowdhury said.

The RBI had kept the bank rate, used as benchmark to price loans, unchanged at 6 per cent in its half-yearly policy outlook, while the short-term repo rate, last cut about a year ago, is at 4.5 per cent.

Analysts, however, cautioned that a possible rise in rates could choke off demand as lower interest rates stimulate growth. “The RBI would like to wait and watch the inflationary trends before taking a decision as the current pressures would ease with a fall in oil prices," said an analyst with a global consultant.

Asked how rising inflation and surging bond yields would crimp profits, Purwar said a strong balance-sheet would help SBI cope with price spikes for some time. He also felt that yields on the benchmark 10-year security would come down soon.

State Bank has a stack of bonds worth Rs 1,85,000 crore and an investment fluctuation reserve of over Rs 4000 crore to deal with rate swings.

That buffer would have eroded by half in the first quarter of the current fiscal, when the bank took a hit of Rs 2000 crore due to surging bond yields. However, the amount was not treated as losses because of a change in Reserve Bank’s accounting policy.

In the notes to its first-quarter accounts, State Bank says the method of valuing investments have been changed to comply with new guidelines.

“Had the earlier system continued, provision (losses from fluctuating bond prices) would have been Rs 2,242.76 crore and the profit-before-tax would have been lower by the same margin,” SBI said. Bond yields and prices move opposite ways. Banks gain when prices go up (yields fall) and vice versa.

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