Short-term rates to move up: O P Bhatt

The hike in CRR is likely to push up short-term lending rates and profitability of banks will be under pressure. The hike will not have any direct impact on liquidity condition since there is ample resources in the system. We have seen some softening of deposit rates, but it may not come down further immediately. The policy supports the objective of growth and stability. Call rates and other short-term rates in the reverse repo and repo corridors are expected to move up. This provides an opportunity for treasury to deploy resources and improve yields to protect margins. - O P Bhatt, Chairman, State Bank of India

Rates to stabilise

The immediate focus of the monetary policy is on liquidity management. The increase in the cash reserve ratio (CRR) will help to a certain extent. The removal of the cap on the reverse repo window will ensure that the short-term rates do not go low. The measures will ensure that excess liquidity does not result in inflation or excessive credit. There is enough liquidity, however, to meet the growth requirements of all productive sectors. Owing to the short-term liquidity, interest rates on shorter-term deposits of up to 1 year can come down by up to 100 basis points. We will be reducing rates on our one-year centenary deposit scheme from 9.5 to 9 per cent. We will review our lending rates after some time depending on how the rates stabilise. Since lending is more for longer period or term loans, interest rates may not immediately come down. Corporates avail of short-term loans at fine rates, so there will not be much downward trend there. The rates will stabilise at current levels. Maybe in the medium term, the rates will be lower. - M B N Rao, CMD, Canara Bank

Right for the moment

The macroeconomic situation does provide some indications of cooling off. Inflation has moderated, while overall corporate profitability during the first quarter has been significantly less buoyant than in recent quarters. The rupee appreciation will also contribute to slowing demand for domestic goods and services. Given all these considerations, it would have been inappropriate for the Reserve Bank of India to continue with increases in its benchmark interest rates. Its decision to maintain the status quo is, therefore, welcome. However, the situation has clearly been complicated by the enormous rise in liquidity due to a number of factors, including capital inflows. While it presumably tries to devise longer-term policy responses to this phenomenon, it has chosen to deal with the problem in the short run by a combination of an increase in the CRR and elimination of the cap on reverse repo acceptances. Overall, the policy was appropriate for the situation, but the situation itself is rather fluid at the moment. - R Ravimohan, MD & region head, Standard & Poor's South Asia

Exports to take a hit

This is a sad day for Indian exporters and IT industry. The difference between Indian interest rates and international rates even after allowing for prudent hedging practices would be around 3 to 3.5 Per cent. With the RBI increasing CRR by 50 basis points and removing Rs 3,000 crore daily cap on reverse repo, domestic interest rates would rise. This will lead to higher arbitrage possibility and greater inflow of foreign funds into India. Consequently, the rupee will get strengthened. During the period (Q2 2006-Q2 2007), the rupee has already strengthened by 9.4 per cent against the US dollar. However, in the same period, the Chinese yuan appreciated by 4.2 per cent, the Korean won by 2.2 per cent and the Indonesian rupiah by a mere 1.4 per cent. This development is going to make us uncompetitive in both manufacturing and IT services exports. In the medium term, it will have a negative impact on employment growth. If the rupee keeps strengthening, any enterprise planning to make India a manufacturing or services hub for exports will have to review its strategy. Further, interest rate hike prompted by the previous monetary policy "pronouncements" have had a deleterious impact on the growth rates of EMI-driven industries such as automobiles and consumer durables. This trend will not only continue, but would get accentuated if interest rates go up further. - Siddhartha Roy Economic Advisor, Tata Group

Inflow challenges remain

The RBI faces challenges on three fronts "" interest rates, exchange rates and inflation. The current measures are aimed at sucking out excess liquidity from the system, continuing its earlier stance. The RBI appears to be comfortable with the current interest rate scenario, while being cautious about the global uncertainties emerging from volatile forex movements and global pricing risks. The challenge of managing volatile capital flows will continue and the RBI will have to employ all instruments in its stable to manage them, thus ensuring that growth momentum is sustained. - Y M Deosthalee, Chief Financial Officer, Larsen & Toubro

Rupee may rise further

A deeper reading of the policy indicates attempts of the RBI to balance global developments and domestic events. The RBI recognises the systemic risks, owing to hedge fund activities and leverage by private equity, mispricing of risk globally and consequent impact of global inflation on emerging markets, including India. I do not find any surprise in statements or actions in the policy. The primary concerns remain capital flow, burgeoning demand with supply not keeping pace, inflation and liquidity. The RBI has understandably outlined priorities in managing inflation below 5 per cent (prefers 4-4.5 per cent) and price stability. On prices, the stance appears inconsistent as the RBI accepts stretched capacities in various industries, but expresses concern over pricing power as a contributor to inflation. On liquidity, like global central banks, the RBI used CRR hike to manage liquidity in this round and hinted at use of OMO and MSS on different occasions. The interest rates were kept unchanged, but the policy indicates rates may be close to peaking out for the time being. In my view though, the RBI has a tough job on hand in view of global developments and would dare to say that over the next 1-2 years, the RBI would be forced to allow the rupee to appreciate beyond the 40 level to provide for 100-150 basis points hike in interest rates and see inflation that is closer to 5 per cent than 4 per cent. - Bharat Banka, Head (Corporate Fin Group), Aditya Birla Management Corp

Battle on against inflation

The RBI reinforces inflation fighting credentials. RBI Governor Y V Reddy announced the credit policy review today. The RBI essentially took out an insurance against potential inflationary pressure by raising the cash reserve requirement by 50 bps to 7 per cent. The RBI also suspended the limit on reverse repo auctions in order to improve liquidity control in an effort to keep short-term interest rates within the LAF corridor. Overnight rates dropped below 1 per cent this week. Both measures should boost rates and add support to the rupee. It was no surprise that the RBI said it would resort to LAF and MSS bonds to contain the rupee strength.

A range of key indicators suggests the RBI's overheating worries of six months ago have ebbed. Inflation has dropped below the RBI's 5-5.5 per cent target band from a high of 6.7 per cent in the January-March quarter (into its medium-term target range of 4-4.5 per cent). Growth in non-food bank credit has fallen on a year-on-year basis, but money supply and reserve money continue to grow strongly driven by surging capital inflows. In sum, we believe the RBI acted prudently for the longer-term stability of growth and inflation even if it roils markets over the next couple of days. There is a reasonable chance that inflation may fall below 4 per cent by end-2007 aided by a strong agricultural harvest and our expectations of declining energy prices.

This would go a long way towards reducing inflationary expectations and securing a high growth-low inflation environment similar to China of the past decade. - Bill Belchere, Chief Economist, Asia Macquarie Securities

Tight liquidity ahead

Broad monetary policy remains the same except that liquidity will become tight. The capital market was expecting that the RBI will do something about lowering the interest rates, but the governor set the priority of mopping up additional liquidity and indicating that foreign investment will continue. The CRR hike and expected increase in interest rates will strengthen the rupee making foreign investment attractive. - Raamdeo Agrawal, Joint MD, Motilal Oswal Securities