Further CRR hikes are quite possible

The RBI8217;s monetary policy for 2008-09 has been formulated with the objective of containing resurgent inflation without hurting the growth process. While the central bank has resorted to another CRR hike of 25 basis points bps, it has left the policy rates unchanged. This suggests that the RBI is content with tightening liquidity in the banking system, to counter resurgent inflation. Tighter liquidity conditions may lead to a slowdown in the pace of bank credit growth further and help contain inflation.

While this approach is beneficial to growth, it may prove to be a risky one in curbing inflation. Headline inflation runs the risk of rising to higher levels in the presence of the strong price pressures emanating from spiralling commodity prices and strengthening demand side pressures. Going forward, therefore, further monetary tightening is likely. The possibility of more CRR hikes becomes apparent if we consider that the RBI8217;s target for money supply growth for 2008-09 is 16.5-17.0 per cent, compared with 20.7 per cent last fiscal year. This does tie in with the RBI8217;s estimate of a lower GDP growth of 8-8.5 per cent, slower pace of bank credit growth and the possibility of an extended slowdown in capital inflows this fiscal. If inflation is not contained, a hike in the policy rate cannot be ruled out either.

Bank lending rates might not move up immediately following the policy move, as there is ample liquidity in the banking system at present. However, considering that the RBI is inclined towards mopping excess liquidity, rates would come under pressure as and when liquidity tightens.

The institutional measures announced in the policy are in the right direction, especially considering the various risks to domestic economic activity and markets from global economic forces. Of particular importance are the measures to develop the financial markets by steps like introduction of currency futures and stripping of government bonds. Also, given the large funding requirements for the infrastructure sector, relaxation of asset classification norms for bank credit to that sector is a welcome move. The other initiatives to improve the credit delivery mechanism and promote financial inclusion are also commendable and will help enhance the reach of the banking sector.