The Telegraph
Since 1st March, 1999
Email This Page
Rate hike dilemma for Reddy

Mumbai, Jan. 22: Reserve Bank governor Yaga Venugopal Reddy is confronted with two key issues while preparing the third-quarter monetary policy review to be unveiled on Tuesday.

He is having to deal with the tricky question of raising interest rates at a time when liquidity in the financial system is tight and demand for credit is growing. He also knows steady rates are a must to keep the momentum in the economy from petering out. At the same time, he might feel the urge to loosen purse strings through a reduction in the cash reserve ratio (CRR).

Treasury and banking experts, however, feel that Reddy is unlikely to touch policy rates, including the reverse repo, repo and bank rates. While the bank rate, through which RBI re-finances banks, stands at 6 per cent, the reverse repo ' the rate at which the central bank mops up liquidity ' is at 5.25 per cent.

In 2005, the RBI had raised the reverse repo rate on two occasions, by 25 basis points each, to 5.25 per cent. However, with inflation under control and, the budget a month away, bankers feel Reddy will not do anything to upset equilibrium in the economy.

Indranil Pan, chief economist at Kotak Mahindra Bank, said markets have started living with higher rates. Several banks have raised deposit rates in recent weeks. Loans given below prime rates (PLR) to firms have turned costlier too, fuelling speculation that rates on retail credit are on the way up.

Some, like Siddharth Mathur, do not agree. The J. P. Morgan strategist expects the Reserve Bank governor to tinker with some rates. On the cards could be a 25-basis point increase, though he is almost convinced the CRR will not be touched.

“Economic activity is growing at a brisk pace but the risk of inflation remains. With more central banks around the world set to tighten policy this year, we believe the time is right for the RBI to raise rates by 25 basis points,” Mathur told The Telegraph.

Mathur could be right. Many parts of the economy have not felt the full heat of the crude price flare-up and the fresh upsurge in recent weeks is pushing the government towards a hike in LPG and other petroleum products. This means higher inflation.

Bond market experts do not expect a cut in the 5-per cent CRR, though bankers struggling to reconcile a 30-per cent credit growth with a 17-per cent increase in deposits are hoping for a 0.25 per cent reduction in the key monetary benchmark.

Liquidity in banks has also been soaked up by the $7-billion payouts on India Millennium Deposits (IMD) last month.

State Bank chairman A.K. Purwar is among those who believe the dry patch on funds will linger till the busy credit season.

Bound for Basel

For banks, particularly the nationalised ones, the RBI may announce guidelines allowing them to raise capital through new instruments such as preference shares and hybrid capital.

These norms are long overdue in the run-up to the Basel II rules, which take effect from April 2007.

The wait is more anxious for public sector banks in which the government’s shareholding hovers around 51 per cent.

Email This Page