What next?

Mumbai, April 27: Reserve Bank of India governor Y.V. Reddy continues to keep the banks on tenterhooks.

With just two days to go before he reviews the monetary policy, bankers are sharply divided over the prospect of an increase in a key short-term rate to combat inflation.

The key question that is being asked is whether Dr Reddy will raise the repo rate or maintain status quo.

The repo rate is an instrument through which the central bank injects liquidity into the system. By raising it, the RBI can control inflationary pressures emanating from the demand side.

The repo rate now stands at 7.75 per cent and has remained unchanged since March last year.

Bankers are already indicating that a hike in this rate will lead to a rise in lending rates.

Several bankers are uncomfortable with the idea of another increase in the table of interest rates, arguing that this can dampen investment in an economy that is already showing worrying signs of a slowdown.

“The governor will, therefore, prefer to keep the rates unchanged as a hike in the repo rate will certainly impact growth. Moreover, he has already raised the cash reserve ratio (CRR) by 50 basis points this month,” says a senior official with the State Bank of India (SBI) who does not wish to be identified.

On April 21, the RBI announced a 50 basis point hike in CRR to check inflation which will come into effect in a two-step process on April 26 and May 10.

The CRR hike will suck out Rs 18,500 crore from the financial system. CRR is that portion of bank deposits, which must be maintained with the RBI.

The official adds that though inflation has risen to 7.33 per cent for the week ended April 12, Reddy will not act in haste and prefer to wait for more data to come in before taking a call on the repo rate.

Those who feel that the repo rate will be raised by 25 basis points aver that the threat of inflation hasn’t receded and the recent actions taken by the RBI are not enough to cool it.

Analysts point out that there can be pressures from the demand side on inflation considering the Sixth Pay Commission report and the tax incentives in the Union budget.

They add that a repo rate hike will have the support of finance minister P. Chidambaram who recently said some growth could be sacrificed to check inflation.

“The higher repo rate will send out a clear signal about the RBI’s resolve to maintain price stability and for banks to raise lending rates,” Han-Sia Yeo, strategist at Bank of America said in a recent report. Han expects a hike of 25 basis points in the repo rate.