What146;s Up, Guv?

Says R. Ravimohan, MD and CEO of S038;P-owned Crisil: 8216;8216;I am expecting the interest rates to go up8230;but there is also heavy demand for money from the corporates which are currently in a major investment cycle.8217;8217;

The RBI is expected to raise key short-term interest rates8212;repo and reverse repo8212;by 0.25 percentage points to 6.75 per cent and 5.75 per cent, respectively on Tuesday. The reverse repo rate short-term rate on bank funds parked with RBI is now 5.50 per cent. And the repo rate at which RBI lends to banks against securities is 6.50 per cent.

If the RBI increases the short-term rates, it could be the fifth increase since October 2004. In January when the RBI hiked short-term rates, banks lifted deposit rates by as much as 1.5 percentage points to attract depositors as they compete with funds going into the booming stock market.

Liquidity Crunch versus Asset Bubble

On top of this, liquidity position is also tight with the RBI under pressure to reduce cash reserve ratio CRR8212;portion of deposits kept with the RBI8212;from the current level of 5 per cent and release more funds to the lendable resources.

However, opinion is divided on CRR cut. 8216;8216;We do not expect the RBI to tinker with the CRR as the liquidity situation is easing out. But it may be taken up later in July 2006,8217;8217; said an analyst with Sharekhan. But speak to bankers, and there8217;s a different view. Says Union Bank of India8217;s ex-CMD K. Cherian Varghese: 8216;8216;Banks need long-term funds and adequate liquidity. One possible way of doing this could be a cut in the CRR.8217;8217;

On another front, the central bank has been flashing red signals about the soaring asset prices; the Sensex is at dizzy heights, bullion prices are soaring and housing/land prices are skyrocketing. In March it said that excessive increases in asset prices and credit had emerged which could lead to financial instability. 8216;8216;The RBI may announce some more safety measures in relation to the banking sector8217;s exposure to the capital market and the real estate sector,8217;8217; said a banker.

Managing Inflation, and FM8217;s Expectations

One school of thought has it that as inflation has fallen below four per cent to around 3.5 per cent level, there8217;s no need for a rate hike or belt-tightening measures. Says D R Dogra, executive director, CARE: 8216;8216;Inflation is manageable at below 4 per cent. So the RBI should reduce CRR to infuse more liquidity in the system. India Inc needs more funds for investment in new projects.8217;8217;

But read what the RBI mentioned in its 8216;Currency and Finance Report for 2004-058217; released last month: 8216;8216;As economies have become more pro-cyclical, inflation is no longer the major indicator of financial stability because strong swings in asset prices could lead to financial instability.8217;8217; The RBI chief will also have to factor in the impact of high crude prices as the government has not passed on the price rise to retail customers.

The Finance Minister has been arguing for a benign interest rate regime. The reason: any rate hike will hit investments in the country. India Inc which has kicked off a massive investment programme will slow down spending. 8216;8216;This could slow down the growth rate in general. It8217;s going to be a tightrope walk8230;Ensuring adequate credit at a low interest rate without creating a bubble in asset prices,8217;8217; said the chief of a nationalised bank. Indeed, Reddy has his job cut out.

With Dev Chatterjee 038; Zeeshan Shaikh