RBI holds key rates, disappoints Dalal Street

Reserve Bank of India (RBI) Governor Duvvuri Subbarao today kept key interest rates unchanged, but indicated that the central bank would remain proactive and use “conventional or unconventional” steps to address concerns arising out of inflation and a sustained rise in money supply and credit growth.

Subbarao’s first policy since taking charge of RBI in September, however, did not specify the measures. Nevertheless, his cautious stance failed to meet market expectations. The Bombay Stock Exchange’s benchmark index, Sensex, fell almost 11 per cent, the rupee dropped to a record intra-day low of below 50 versus the dollar and the yield on the benchmark 10-year bond climbed 12 basis points to 7.68 per cent.

 

With RBI keeping rates steady, bankers indicated that they will wait before paring lending rates. Though there was a liquidity crunch in the market till 10 days ago, the central bank’s moves that injected Rs 185,000 crore into the system, have created a situation where banks are parking surplus cash with RBI. The continuous depreciation of the rupee, prompting RBI intervention, is, however, sucking out liquidity and is a cause of concern for bankers.

The global financial turmoil and the challenge of sustaining the growth momentum have prompted the central bank to focus on supervision of banks to ensure stability in the Indian financial system. To this end Subbarao announced that the regulator would review banks that have seen steep credit growth relative to sources of funds and the whittling down of excess investments in government bonds. Continued on Page 2

The move also came against the backdrop of the governor flagging that credit growth of over 29 per cent exceeded 20 per cent projected by RBI this year.

Subbarao also said he would carry forward plans for consolidated supervision of financial conglomerates in addition to a review of the activities of trusts and special purpose vehicles set up by banks to increase transparency in their risk-taking.

The global turmoil also prompted the central bank to delay the introduction of credit derivatives in the Indian market, but it intends to roll out interest rate futures early next year.

With the credit crisis putting pressure on funds flow for Indian banks, Subbarao also announced that the cost ceiling for trade credit would be eased.

The measures are in addition to the steps taken over the last few weeks which included a 250 basis point reduction in the cash reserve ratio (CRR), or the proportion of cash banks must set aside, in three phases but effective October 11, and a 100 basis point cut in the repo rate, or the rate at which the central banks lends to banks.

In New Delhi, the government has also eased external commercial borrowing norms and RBI has opened special windows for mutual funds and farm debt relief scheme-related arrears.

With the global turmoil expected to impact emerging markets like India, the central bank also lowered the estimates for economic growth to 7.5 per cent to 8 per cent for 2008-09 from 8 per cent in July. It kept its inflation estimate unchanged at 7 per cent by March 31, 2009 on hopes that declining commodity prices will cool prices.