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RBI veers towards rate status quo

Mumbai, Oct. 28: The Reserve Bank of India is unlikely to rejig short-term rates or the cash reserve ratio (CRR) on Tuesday when it undertakes the mid-term review of the monetary policy for 2007-08.

Two factors are expected to persuade Reserve Bank of India (RBI) governor Yaga Venugopal Reddy to hold his hand: first, inflation is at its lowest level in five years at 3.07 per cent for the week ended October 13 and second, there is adequate liquidity within the financial system.

There is a third factor that is a source of concern for banks: credit offtake has slowed to 22 per cent from well over 30 per cent a year ago.

“There will be status quo. While inflation is benign, excess liquidity in the economy is not much,” says Harihar Krishnamurthy, head of treasury at Development Credit Bank.

A rate freeze could spell good news for retail borrowers who have been spooked by rising interest rates since 2004. Interest rates have risen by 300 basis points since 2004. One basis point is one hundredth of a percentage point.

In the past few weeks, several banks have been slashing interest rates on a range of new retail loans. However, existing borrowers haven’t been granted any relief.

Krishnamurthy reckons that banks will have to take a call on bringing down interest rates on advances. He feels that banks will be able to cut loan rates only if they are able to trim deposit rates to reduce the spread between the two rates.

Some banks, such as the Union Bank of India, have already brought down their deposit rates, but there is no indication that the others will do the same.

Bankers will be keenly analysing the tone of Reddy’s statements, which will come just a day before a crucial meeting of the US Federal Reserve. The Fed is widely expected to trim its short-term rate to jump-start the stuttering US economy.

If the Fed cuts rates, as widely anticipated, the interest rate differential between India and the US will increase to around 3 per cent. Bankers say that in such an event, more funds could flow into emerging economies like India.

It is here that caution steps in. There are a few who feel that the rate tightening may still not be over and that there could be at least one more hike in view of various factors that include the dramatic surge in global crude oil prices and fund flows into India.

Senior bankers are not ruling out the possibility of the RBI governor raising the reserve requirement of banks later this year to fight inflation. The CRR, which is that portion of bank deposits that must be maintained with the Reserve Bank, now stands at 7 per cent.

Bankers say that although inflation has slowed down, there are certain worrying signals. Crude oil prices recently touched $92 per barrel.

Moreover, increasing fund flows into India could lead to higher liquidity.

This is because the RBI has been intervening in the market to protect the value of the rupee, but this releases rupee funds into the system. Higher liquidity could stoke inflation.

“There are two major risks to inflation. First, domestic fuel prices do not reflect the true picture. Given the fact that under recoveries of oil companies are rising, fuel prices could be hiked. Second, India could continue to attract portfolio and FDI inflows, despite Sebi’s recent clamp down on participatory notes to moderate capital inflows. This will put pressure on the RBI to intervene in the forex markets,” said Rupe Rege Nitsure, chief economist at Bank of Baroda.

Nitsure is of the view that the RBI can hike CRR by 50 basis points before December to suck out liquidity and put a leash on inflation.

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