RBI looks for a quick exit with 75-bps hike in CRR

RBI looks for a quick exit with 75-bps hike in CRR
Economic Times, January 30, 2010, Page 1

Urges Govt To Return To Fiscal Consolidation

Team ET MUMBAI

DUVVURI Subbarao on Friday sent out an unequivocal call for help to the government, likening his dilemma of exiting from an expansionary monetary policy to that of Pandava warrior Abhimanyu in the Mahabharata war.

In an uncharacteristically strong message, the Reserve Bank of India (RBI) governor told the government that it should help prevent a monetary policy trap by returning to the path of fiscal consolidation as the central bank began to hasten its exit with a 75-basis-point increase in banks’ cash reserve ratio (CRR), or the portion of deposits they must keep with RBI.

He kept interest rates at record lows and raised the economic growth and inflation forecast for the current fiscal year as business sentiment improves, industrial recovery gains momentum and the services sector grows with improved financing and easing global markets. Economic expansion is inflating commodity and asset prices too.

Abhimanyu, the star-crossed son of Arjuna, penetrated the labyrinthine ‘Chakravyuh’ erected by the Kauravas, but lost his life not knowing how to get out. Arjuna, the only other warrior capable of breaching the formation as well as escaping from it, could not come to his son’s aid as he was distracted fighting another battle.

“This time around, the policy decision was much more complex and challenging than in the last one-and-a-half years. Getting out of an expansionary policy is much more difficult than getting into it. I was telling the banks this morning it is like a Chakravyuh in Mahabharata—you know how to get in but not many people know how to get out,” Mr Subbarao told reporters after the quarterly monetary policy review.

The RBI governor is attempting a deft exit from the ultra-loose monetary policy that he walked into to avoid a serious economic crisis after the bankruptcy of Lehman Brothers in 2008. While the measures have mostly paid dividends, their sudden withdrawal could act as a drag on the improving growth rate, something which neither the political nor the business class wants to see.

As RBI attempts to contain inflation perceptions to pre-crisis levels of 4-4.5% and the medium-term objective of 3%, its objective could be frustrated by a large fiscal deficit, Mr Subbarao said in his policy statement.

“As the recovery gains momentum, it is important that there is co-ordination in the fiscal and monetary exits. The reversal of monetary accommodation cannot be effective unless there is also a rollback of government borrowing,” he observed.

SPRINGING A SURPRISE

What does the CRR hike mean?

While a 50-bps hike was factored in, RBI has surprised with a 75-bps hike. It appears to have gone in for the kill rather than take half measures.

Will the hike push up interest rates?

Unlikely in the short term, as banks are not finding enough takers for surplus funds. Home loan is the only segment showing decent growth, but competition may keep rates low. Govt borrowing targets in Budget will determine long-term rates.

What will this mean for banks?

Banks’ profits will come under pressure & their spreads will be narrowed by 7-10 bps. An increase in bond yields will also hit treasury profits.

Will inflation come down?

RBI expects prices to go up further before they start coming down in July. If the government does not overspend and there is a normal monsoon, prices are expected to fall in Q2 of FY11.

Rs76,974 cr Surplus liquidity since early Jan

Rs 36,000 cr
Liquidity to be sucked by CRR hike

Rs 2,21,369 cr Deposits banks need to raise in Q4’10 to meet 17% growth forecast

Rs 1,98,830 cr
Loans banks need to extend in Q4'10 to meet 16% growth forecast

Rs 7,000 cr Unfinished govt bond auction for the year

7.5%
Revised growth target for 2009-10

8.5% Revised inflation target for FY10