In its monetary and credit policy announced today, the Reserve Bank of India (RBI) hiked all its key policy rates by 25 basis points (bps: one basis point is one-hundredth of a percentage point). With this move, the repo rate (the rate at which the central bank lends short-term funds to banks) stands at 5.25 per cent; the reverse-repo rate (the rate at which banks deposit their short-term surplus funds with the central bank) stands at 3.75 per cent; and the Cash Reserve Ratio (or CRR: the percentage of bank deposits that must be kept with the central bank) at 6 per cent. The 25 bps hike in CRR will mop up liquidity to the tune of Rs 12,500 crore.
These rate hikes were largely in line with market expectations; most market participants expected the rate hikes to be to the tune of 25-50 bps.
Banks unlikely to hike rates immediately
Jay Shankar, chief economist, Religare Capital Markets, is of the view that banks are unlikely to raise their rates immediately as there is still adequate liquidity within the banking system. More than Rs 50,000 crore still gets parked in the RBI’s reverse repo window.
Further, the RBI’s measure must also be seen in the light of its job of managing the government’s borrowing programme. “The current dovish policy move may be aimed at keeping the borrowing programme running smoothly and at cost low,” he said.
In its annual budget the government had put up an ambitious divestment target of Rs 40,000 crore. “It will thus be prudent to keep the markets happy in order to successfully raise the targeted amount from public offers; hence the calibrated and gradual rate hike,” said Jay Shankar.
He would, however, have preferred a steeper rate hike now. “The risks of RBI losing its ammunition much faster in its fight against inflation later also increases as policy impact weakens at the margin. Then there is also the fact that monetary policy response has a distinct lag in India. We believe that the new normal inflation has got elevated to 6.5-7 per cent now, above RBI’s erstwhile comfort zone of 5 per cent,” he said.
Inter-policy hike likely
Rohini Malkani, economist, Citi India is of the view that another rate hike could occur before the next policy announcement on July 27. “The RBI appears comfortable with sustained growth, given the uptrend in exports, the broad-based industrial recovery, the uptick in services, and improved corporate profitability. This coupled with the increase in flow of funds to the commercial sector is the key to its view that the ‘domestic balance of risks shifts from growth slowdown to inflation’. Moreover, the RBI has stated that ‘despite the 25 bps hike, our real rates are still negative…and with the recovery now firmly in place, we need to move in a calibrated manner in the direction of normalising our policy instruments’. Hence we are of the view that a minimum additional 75 bps hike in 2010 is likely, with a possibility of an inter-policy hike before its July 27 meeting,” she said.
Short-term rates to remain benign
Maneesh Dangi, head-fixed income, Birla Sun Life Mutual Fund expects short-term rates to remain benign. “We believe that for the first half, the balance of considerations will weigh in favour of adequate systemic liquidity, which will support a benign short-term rate curve. As for G-Secs, notwithstanding the lower budgeted borrowing for the current financial year, fresh issuance of securities in the current year is Rs 90,000 crore more than the previous year, in a regime when liquidity conditions are going to be less benign and credit demand is likely to pick up. Thus, we believe that the G-sec curve will remain under pressure for some more time,” he said.
Pressure on long-term rates
According to Alok Sahoo, head of fixed income, Baroda Pioneer AMC, “Short-term interest rates will move up due to the hike in reverse repo rate and reduction in liquidity from the system. Large government borrowings during the first half of FY11 will put pressure on long-term interest rates.”
Improved funding norms for infrastructure
Another notable point about the monetary and credit policy was the easing of financing norms for infrastructure companies. Said Ramanathan K, CIO-single manager, ING Investment Management India: “A positive for infrastructure companies is the provision for infrastructure bonds to be held in the HTM (hold to maturity) category and the reduction in provisioning norms of infra sub-standard assets.” Banks will now be able to park their extra liquidity in higher-yielding bonds without worrying about their interest rate sensitivity.
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