By Manish Sharma

The Reserve Bank of India (RBI) has chosen to continue with its calibrated approach to exit from its expansionary policy stance in the first quarterly monetary policy review (2010-11). Although there is a general consensus among policy makers that the central bank is falling behind the policy curve, RBI governor D. Subbarao feels the time is not ripe to jack up interest rates substantially lest it might derail the growth cycle.

Before the annual policy announcements, there was speculation that the central bank may adopt a more hawkish stance. But the RBI authorities chose not to disrupt the growth momentum. The central bank increased its key policy rates – repo (overnight lending rate) and reverse repo (overnight borrowing rate), along with the cash reserve ratio, or CRR,(share of time and deposit liabilities) - by a quarter point (25basis points) each. This brought the reverse repo rate to 3.75 per cent, the repo rate to 5.25 per cent and the cash reserve ratio to 6 per cent.

This is the second time in two months that the RBI has hiked its policy rates, after raising them by similar margin last month. Nevertheless, a hike of 50 basis points in interest rates is not going to affect the liquidity in the banking system. Despite credit off-take picking up considerably during the past few months, banks still have excess funds being parked with the RBI through the reverse repo facility. Banks had parked surplus liquidity of Rs 1.2 trillion at the reverse repo window as on April 8, 2010. Even a day after the policy announcements, banks deposited Rs 500 billion with the RBI. Thus, CRR hike or policy moves will not squeeze the liquidity out of the system.

There are reasons as to why the RBI did not adopt an aggressive approach. The government has a massive borrowing programme lined up this year and any adverse movement in interest rate scenario would add to the interest cost, even though it is an off-balance sheet item. The RBI plans to raise Rs 2.8 trillion of the government’s borrowing programme during the first half of 2010-11, which equals to 67 per cent of the total borrowings. Since excess SLR investments (stipulated government investments), including reverse repo, are estimated at over Rs 2.5 trillion, the RBI governor is confident of managing the government borrowing programme for the period without crowding out the private investments. Moreover, banks have an alternate pool by way of their Rs 1.1 trillion investments in liquid mutual funds to cater to credit demand. Also, a hike in interest rates would lead to capital inflows due to interest rate differential between the US and India, causing the Rupee to appreciate further.

Still, the approach may not work for the RBI as this is the first time the economic growth, inflation and interest rates are moving in the same direction. The headline inflation is on the verge of breaching the double-digit mark and food inflation rose 17.65 per cent in the week ended April 10 from a year earlier. The RBI is now worried that after food inflation, manufacturing inflation too is showing an upward bias. The industrial output has registered a growth of 15 per cent for the past two months. And non-oil imports have been growing at brisk pace.

In the coming months, a below par monsoon and flaring of oil prices would upset the RBI calculations. For the moment, the Rupee appreciation is taking care of any hike in oil prices and since the slack season is on, the credit disbursal is expected to be tepid. Yet, the RBI is behind the curve. In the next half of this fiscal, it will have a lot of ground to cover. It can’t afford to feel the stones while crossing the river then.

Indiabiznews, May 04, 2010