RBI hikes cash reserve ratio, keeps rates same

Faced with huge foreign capital inflows, the Reserve Bank of India continued with its hawkish vigil on the banking system.

Faced with huge foreign capital inflows, the Reserve Bank of India (RBI) continued with its hawkish vigil on the banking system. Continuing its tight monetary policy regime, it hiked the cash reserve ratio (CRR) — the portion of bank deposits to be kept with the RBI — by half a percentage point to 7 per cent to suck excess liquidity out of the banking system.

With inflation falling below the 5 per cent level, the RBI, in its first quarter review of monetary policy, kept benchmark interest rates like the repo rate (the rate at which RBI lends funds) and reverse repo rates (the rate at which the RBI absorbs excess funds) steady at 7.75 per cent and 6 per cent respectively. It had hiked these rates five times since June last year, leading to an across-the-board rise in interest rates in the last one year. While lending rates will remain steady, the move is likely to lead to a fall in deposit rates as bank profitability will come under pressure. Three banks — Bank of India, Canara Bank and Bank of Baroda — cut rates on one-year deposits within hours.

The CRR hike will impound Rs 16,000 crore of lendable resources of banks, mainly infused by RBI’s intervention in the foreign exchange market while mopping up the dollars coming into the system. The central bank also removed the Rs 3,000 crore limit on reverse repo lending — for liquidity absorption — putting further upward pressure on short-term interest rates.

In his statement, RBI governor Y V Reddy spoke about the “strong pace” in economic activity, gains in bringing down inflation, persisting inflationary pressures, the worrying aspects of foreign capital flows — especially hedge funds — and risks from global developments. “Growth continues to be strong and an 8.5 per cent growth projected was a good figure. Growth impulses are strong and we can be positive on growth,” Reddy said.

According to HDFC Bank chief economist Abheek Barua, “The RBI’s moves are an effort to pre-empt inflationary pressures that easy liquidity and low short-term rates could foster.

Reddy expressed concerns over the role of hedge funds. “With greater risk aversion going forward, with credit quality deteriorating and with the widening of credit spreads, the potential fragility of hedge funds could pose significant risks to financial market stability and to the prospects for financing and growth in the emerging market economies.”

Banking stocks remain firm

Under normal circumstances, banking stocks would have reacted negatively to a hiked CRR but we didn’t see such a reaction. The banking index was up 1.2 per cent. Only four banks out of 18 in the BSE Bankex saw a decline in their share price. SBI, which carries a 16 percent weightage in the index, was up 2.9 per cent, HDFC Bank was up 3.3 per cent and ICICI Bank was up 0.4 per cent. Says Emkay Share and Stock Brokers head of research Ajay Parmar: “The overall sentiment in the market is that there is enough liquidity. So the CRR hike will not have a big impact.” Sharekhan head of research Sandeep Nanda adds: “We don’t see any signal of a rate hike and the strong liquidity condition has held the market though the credit policy holds negative signals for bank earnings.”

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RBI’s focus on liquidity management will limit inflation. Immediate impact of CRR hike will be to drain excess liquidity from the system. There is need for caution on domestic liquidity and developments in financial markets abroad
O P Bhatt, State Bank of India

Global events such as credit concerns and US’ mergers and acquisitions appear to have played a vital rolein the RBI’s decision to hike the CRR. These policy measures will notimpact economic growth
Kalpana Morparia, ICICI Bank

The measures will help normalise overnight rates, which have fallen to unprecedented low levels. They will help control demand conditions in the economy and ease asset price inflation. For banks, cost of funds are likely to go up. That may exert mild pressure on lending rates
Romesh Sobti, ABN Amro Bank

The policy has focused on assessing the existing inflationary environment and addressing inconsistent signals emanating from near zero overnight interest rates that could cause long-term interest rates to move lower
Naina Lal Kidwai, HSBC India

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The reduction in credit has slowed down to 24 per cent compared to 31 per cent a year ago.The policy statement doesnot seem to have taken serious note of this fact
Ashvin Parekh, Ernst & Young