Beg, but don't borrow

NO APRIL Fool’s joke, this. Interest rates on most loans, including home loans, could rise by half to one percentage point with the Reserve Bank of India announcing a slew of tightening measures on Friday evening. The measures pass on the burden of managing inflation to borrowers and banks who will pay by way of higher rates and lower profits.

With foreign funds inflow expected to surge and the government about to step up spending at a time when inflation fears continue to haunt, the RBI has chosen to hit the markets with direct, blunt measures that will drain liquidity and make money more costly.

The move aimed at removing the froth from the economy - in the form of speculative investments and consumption demand - may end up moderating economic growth as well. The banking system, already starved of liquidity, will find the going the tough, while stocks could turn edgy when the market opens on Monday.

RBI’s measures include half percentage point hike in cash reserve ratio - the part of deposits that banks have to keep with the RBI as cash - to 6.5%, and a 25-basis point hike in repo rate - the rate at which banks borrow from the RBI - to 7.75%. Also, banks will get far less returns on money parked in CRR with interest rates on CRR halved to 0.5%. At the same time, the central bank has said it will impound another Rs 6,000 crore through an auction under the market stabilisation scheme on April 4.

Even before the system could digest the previous dose of tightening measures, the monetary authority has struck again. It is widely perceived that the RBI is also being influenced by think-tanks within the government.

Just as former Fed chief Alan Greenspan still moves the US market, Chakravarty Rangarajan, chairman of the PM’s economic advisory council and former RBI governor, continues to have an influence on RBI governor YV Reddy’s monetary policy, albeit in a subtle, indirect manner. Mr Rangarajan, a hard core monetarist, is dead against the spiralling growth in money supply - one of the factors that have fuelled the latest bout of inflation.

This is the third in the series of monetary squeeze in four months. Incidentally, the other two hikes were announced outside the monetary policy review on December 8 and February 13. Despite these, year-on-year credit growth was 29% on March 15.

Friday’s CRR hike has dashed all hopes of any immediate easing of rates. Some banks had refrained from raising rates hoping that the RBI was at the end of its tightening phase.

Those banks that have held back rate hikes earlier will now be forced to hike it by at least 100 basis points.

Unlike in the past, this April will turn out to be the cruelest month for the money market. Assuming the end-March tightness to be transient, some banks sanctioned loans but postponed disbursements to April.

Large corporates would be spared to the extent that they are able to borrow from overseas where overall costs have become cheaper with the rupee firming up. Hemant Mishr, MD, global corporate sales, South Asia, StanChart, said: “The difference between an all-hedged foreign currency funding has fallen from 100 basis points to 55 basis points given the upside move on the cost of hedging. Some banks feel it could be RBI’s strategy to let the rupee firm up through higher rates in order to make imports cheaper and bring prices down.”

In a statement, which bankers termed hawkish, the RBI highlighted economic indicators that called for tightening. These included a rise in the index of industrial production to 11% from 8% a year ago. Moreover, inflation had held firm at around 6.5% for three weeks in succession. This was on account of a 12% increase in prices of primary articles and 6.6% rise in cost of manufactured articles. Besides, the year-on-year money supply (M3) growth up to March 16, 2007 was 22% as against 16.9% a year ago.