RBI may not raise key policy rates

Economists, bankers, however, think CRR likely to go up 25 per cent

The Reserve Bank of India (RBI) may not raise its key policy rates at the monetary policy review on October 27, but there is an outside risk of an increase in bank cash reserve requirements, or the cash reserve ratio (CRR).

A cross-section of bankers and economists who met the RBI top brass last week said the central bank’s talk will turn a bit more hawkish, but the slow credit pick-up and the underlying risks would stop it from raising rates.

RBI cut its main lending rate 425 basis points between October and April to 4.75 per cent as the global downturn struck. It slashed the CRR to 5 per cent from 9 per cent between October and January.

Economists and bankers said both RBI and fiscal policy makers’ dilemma was timing the exit from the central bank’s “accommodative policy” in view of rising interest rates. The dilemma is how to boost growth without fanning inflation.

RBI Governor D Subbarao had flagged this in a speech in Istanbul on October 5 in the wake of rising inflation and signs of economic recovery. “While there is a broad agreement that we need to exit from the present excessively accommodative monetary and fiscal policies, there is less agreement on when and how we should exit. An early exit on inflation concerns runs the risk of derailing fragile growth, while a delayed exit may engender inflation expectations,” Subbarao said.

However, two bankers present at last week’s meetings said they got the impression that RBI was considering a 25-basis points increase in the CRR as the central bank was looking to sterilise capital inflows. Foreign investors have made net purchases of over $13.5 billion in stocks and bonds so far this year.

A 25-basis point increase in CRR will suck out around Rs 30,000 crore from the system, but bankers said their margins would come under further pressure if this happens. Banks’ net interest margins are already under pressure, owing to successive lending rate cuts and high-cost deposits raised in September last year.

Another banker suggested such a move may not be prudent, since credit growth was expected to pick up in the last two quarters. If CRR was raised now, there might well be a liquidity crunch, he said.

Economists, however, argued that raising CRR at this point in time would not solve the problem of excess liquidity.

M Govinda Rao, director of the National Institute of Public Finance and Policy, said “Inflationary pressures are still not there. The current inflation is a supply-side phenomenon, and not a general phenomenon. You have to tighten only when it becomes a general phenomenon. At this particular juncture, it is not appropriate for anybody to withdraw the stimulus.”

A section of economists also said RBI should cut down its open market operations, which have added to the excess liquidity, rather than raising CRR.

“Raising rates or the CRR later this month will not affect inflation expectations, as the tightening would not ease the underlying supply-side pressures that are causing food inflation. But premature tightening could sap the strength of the unfolding recovery, which is still in its infancy,” said Rajeev Malik, analyst with Macquarie Research.

Malik said RBI might keep policy rates unchanged in the October review and it might raise these in the next review scheduled for January next year. Many economists said it was not yet clear when the unwinding of the ‘‘accommodative monetary policy’ should start.

“It depends how the Indian and the world economy behaves. It depends on what sort of inflation pressure is coming. One has to wait and watch. Therefore, at this juncture, RBI should continue to have an accommodative monetary policy,” Rao said.