Easing liquidity may lower pressure on rates

The coming quarters might see a reduction in the pressure on interest rates due to easing of liquidity and a fall in government balances. However, commercial banks would have to address the structural mismatch between deposit and credit growth through rate adjustments, said the Reserve Bank of India (RBI).

“During the third quarter of 2010-11, interest rates in most segments of the financial markets shot up, mainly reflecting deficit liquidity conditions. Going forward, the recent substantial easing of liquidity conditions on account of policy actions initiated by the Reserve Bank and reduction in the unusually high government balances may reduce the pressure on rates,” RBI said in its Macroeconomic and Monetary Developments Third Quarter Review.

While the central bank expects volatility in asset prices and exchange rates to continue on the back of volatile portfolio inflows, maintaining orderly conditions in various segments of the financial markets would continue to be its policy priority. In the wake of tight liquidity conditions over the past six months, banks had been witnessing higher credit growth compared to deposit growth. Bank deposits as on June 2010 had grown 14.5 per cent annually and gross advances by all commercial banks by 20.4 per cent.

Scheduled commercial banks (SCBs) raised deposit rates to step up fund mobilisation to support credit growth. Several banks revised their base rates upwards in the range of 25-100 basis points between then and last Monday. Forty SCBs also increased their prime lending rate by 50-150 bps in the period.

“In January 2011, equity prices moderated, partly reflecting market expectations of tighter monetary policy in response to higher inflation. The forex market also remained orderly and witnessed two-way movements. The severe tightness in liquidity that developed in the last few months of 2010 impacted rates in different segments of the money market. The interest rates/yields on overnight, CPs, CDs, CBLO, Treasury Bills, government dated securities and bank deposits increased. Housing prices in major cities rose in general in the second quarter of 2010-11 and to contain excessive leveraging in the housing sector, the Reserve Bank tightened prudential measures for housing credit,” the report added.