Dark clouds are gathering over over the economic horizon with rising inflation threatening to push up interest rates and bring down the growth. Though the Reserve Bank of India is not in a hurry to act and hike key benchmark rates like bank rate, repo rate, reverse repo rate and cash reserve ratio, pressure is building up in the system with many banks deferring rate cuts and instead looking at ways to increase rates.With the tide turning in the last three months, bankers have started feeling the pressure. “It’s one of the tools used by the central bank to keep inflation under control. Demand for local currency funds is expected to be high this year given the restrictions on ECBs (external commercial borrowings) and the weak sentiments in the stock market. Also global liquidity is drying up and credit spreads have blown out thus forcing corporates and financial institutions to borrow from domestic markets which could put further pressure on interest rates,” said Prakash Subramanian, MD, Standard Chartered Bank.Indicating that it’s in a wait-and-watch mode, the RBI has already said that it would come out with an appropriate policy statement on April 29, when it unveils the annual monetary policy. “And, of course, the detailed response to that will come in the annual policy statement, which is on April 29. We are examining the data, both on international and domestic developments, on a regular basis,” RBI deputy governor Rakesh Mohan said last week.While repo rate (rate at which RBI lends money to banks) is currently at 7.75 per cent, reverse repo rate (banks’ returns on excess funds parked with the RBI against Government securities) is fixed at 6 per cent. Other weapons to fight the inflation available with the RBI include a hike in cash reserve ratio — portion of bank deposits to be kept with the RBI — from the current level of 7.50 per cent which would suck out liquidity from the banking system. The central bank has the option of allowing the rupee to appreciate further and suck out the Indian currency — released while purchasing the dollar — through market stabilisation bonds. The Federal Reserve has cut US interest rates by 3 per cent since their peak last year in an aggressive bid to shore up the ailing US economy. In comparison, the RBI is yet to come out with any reduction in key rates. However, some nationalised banks that had recently cut the lending rates are in a bind. “Forget about a rate cut, we are now thinking of a hike in rates. If the RBI sucks out more liquidity from the system with a hike in CRR, there could be a rollback in the recent rate reduction,” said the chief of a public sector bank. “Interest rates, in the present situation, have hardly anything to do with the higher inflation figures. It is a supply-side phenomenon so there is no need for any step for tightening the monetary situation in the economy. If at all the RBI takes any measure, it might be a hike in the CRR rate. The move will in turn soak liquidity from the markets leading to a hike in interest rates,” said Rajiv Kumar, director and chief executive of Indian Council for Research on International Economic Relations (ICRIER). Any monetary measure at this point will lead to high cost of borrowing thereby causing a liquidity-crunch sentiment in the minds of investors. The credit growth rate this year has been only 22 per cent compared to last year’s 36 per cent. The price spiral is being triggered by the global rise in food and commodity prices. The Government has already started taking fiscal steps to control prices — it thas banned the export of many commodities like cement and removed export sops on others. “Presently what we are seeing is an imported form of inflation which is completely commodity driven. Globally steel prices are up and wee are seeing the situation being replicated in our country. As far as controlling liquidity is concerned, RBI is already taking steps through issue of short-term MSS bonds,” said Arpit Agarwal, head of equity research, Arihant Capital Markets.Finance Minister P Chidamabaram has already indicated that the government was prepared to sacrifice the growth a bit as part of its fight to control prices. This indicates that the government and the regulator could go for a rate hike to slow down the economy and bring prices down. This’s bad news for India Inc — the major borrowers in the system — which wants high growth and lower rate. Even those who have taken home loans are worried about the impact of any rate hike on their repayment plans.IN the RBI’S ARMOURY• Hike repo and reverse repo rates and bring down credit demand further• Increase cash reserve ratio and suck out liquidity from the system• Allow the rupee to appreciate against the dollar and prevent release of more Indian currency • Issue more market stabilisation bonds and suck out liquidity
