ICICIDirect - RBI policy update

In a surprise move, the RBI on Friday hiked the short term interest rate
(repo rate) and cash reserve ratio (CRR). It raised the repo rate by 25
basis points to 7.75%. The central bank also raised the CRR by half a
percentage point. The CRR will rise to 6.50% in two tranches, the first on
April 14 and the other on April 28. The CRR hike will drain Rs 15,500 crore
from the banking system. Though the move may impact banks in the short-term,
we believe it would help economic growth over a longer term.

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Banks mull strategy after RBI hikes rates

A day after ICICI Bank upped its lending rates following RBI's key rate hikes, several lenders were mulling their response even as IndusInd Bank hinted at a possible rise this week.

Two private sector players - Yes Bank and ICICI Bank - hiked their prime lending rates (PLRs) over the weekend in response to RBI's move to hike repo and CRR rates on Friday.

"The days of absorbing increasing cost of funds are over. The RBI's move will definitely impact our cost of funds," IndusInd Managing Director Bhaskar Ghose told media here.

The bank will take a "balanced view" so that its business does not get affected by any sharp rise in its lending rates, he said.

"Some banks have already hiked their rates. We will see what the larger banks do," he said, adding "while we have no intention of absorbing the cost of funds, we will take our decision next week."

"You can certainly expect a minimum 0.25 per cent hike but it could go up to 0.50 per cent." IDBI Bank Deputy Managing Director Jitender Balakrishnan, while admitting that the cost of funds would go up, however, said the public sector lender would take a decision on hiking its lending rates only after "discussing the matter".

"The hike in repo and CRR will definitely impact our cost of funds. But whether we increase our lending rates or absorb the costs will be decided only at our board meet," he said.

Decisions to hike rates are taken at the Board level and IDBI Bank's Board is not scheduled to meet till end-April, he said, indicating that any possibility of an immediate response by the bank was remote.

RBI hikes repo rate by 25 bps

In a stylised mock charge on "inflationary expectations", the RBI on Wednesday marked up the cost of money it lends to banks against securities under repo by 25 basis points to 7.50 per cent. At the same time, it lifted growth projections for the current fiscal to 8.5-9 per cent over its last estimate of 8 per cent. All other key markers were left unchanged by the RBI as a springtime offer to the economy.

To contain "sharp increases in asset prices as well as greater volatility in financial markets", the RBI Governor, Dr Yaga Venugopal Reddy, has raised provisioning on standard assets against loans to the real estate sector, outstanding credit card receivables, loans and advances qualifying as capital market exposure and personal loans to two per cent from one per cent. Provisioning for loans to housing, agriculture, SMEs and industry remain unchanged.

Banks will have to provide two per cent (existing 0.4 per cent) on exposures in standard assets to non-deposit taking NBFCs while the risk weight goes up to 125 per cent from 100 per cent.

Focus points

At a press conference, the RBI Governor said the focus was on price stability and credit quality. The Deputy Governor, Dr Rakesh Mohan, added RBI would not hesitate to use all policy instruments, including CRR, to manage liquidity. Bankers may wait a while, having chalked up deposit and lending rates in recent months.

The Third Quarter Review of Annual Statement on Monetary Policy for 2006-07 wants to douse "inflationary expectations" by sticking to the 5-5.5 per cent band. If over the last two years, soaring crude prices pushed RBI to make money dear, today there is concern over the uneven farm performance.

Industry and services sector are growing at a hopping pace while agriculture growth "has not been as sanguine" with output dropping in the first half of 2006-07 over that a year ago. Supply-side pressures due to "declines in the production of rice, coarse cereals, oilseeds, pulses and cotton have emerged as a source of concern for the near-term outlook, especially in view of the relatively low levels of food stocks," says the RBI.

Foreign deposits are being discouraged with interest rate ceilings on NRE and FCNR(B) deposits being pruned by 50 and 25 basis points respectively. Also, banks have been prohibited from granting fresh loans in excess of Rs 20 lakh against these deposits.

Task at hand

Yet that leaves RBI with the trying job of ring fencing the impact of dollar inflows with net accretion to forex reserves (excluding valuation changes) being $ 8.6 billion in April-Sept. 2006. Additional liquidity of Rs 13,040 crore was absorbed under the MSS till January 25, 2007 and balances under MSS swelled from Rs 29,000 crore on March 31, 2006 to Rs 42,040 crore as of January 25, 2007. If the RBI does not absorb dollars, the rupee tends to appreciate whereas soaking up the greenback frees rupee funds into the system.

Non-food credit expanded by Rs 4,07,735 crore (31.2 per cent) as on January 5, 2007 on top of a rise of Rs 3,11,013 crore (31.2 per cent) a year ago.

Provisional numbers for October 2006 shows a rise of 33.4 per cent in credit to retail and services sectors, forming 49.2 per cent of total non-food bank credit with the share of retail at 25.9 per cent.

Loans to commercial real estate rose by 83.9 per cent with its share in total non-food bank credit being 2.5 per cent.

Money flows to the farm sector (which has a share of 12.1 per cent in total bank credit) grew by 30.8 per cent by October 2006 while the share of priority sector advances dipped from 36.5 per cent to 35.2 per cent.

RBI marks up key rates; aim is to ensure price stability

In yet another attempt to ensure price stability, the Reserve Bank of India on Friday upped the repo rate by 25 basis points from 7.50 per cent to 7.75 per cent and the Cash Reserve Ratio (CRR) by 50 basis points to 6.50 per cent in two phases effective April 14 and take out Rs 15,500 crore from the system.

Also, banks will be earning less on CRR with the RBI snipping interest rate to 0.5 per cent per annum from the present one per cent effective April 14. Banks earn nothing on the minimum CRR of 3 per cent and will now get less on the extra 3.5 per cent.

The move may not hit bank balance sheets for the fiscal ended March 31, 2007, as the twin RBI announcements came after banking hours on Friday.

But the fiscal starting April 1, 2007, could see retail and corporate loans turning costly with deposit rates also going up. Market players were stumped for words as the repo rate (the cost of bank borrowings from RBI) and CRR (the percentage of deposits immobilised by RBI in cash) hikes come when rupee funds are hard to come by.

Policy shift

The RBI, in its elaborate explanation, admits to a sure policy shift to douse inflation and inflationary expectations albeit at the cost of growth. Its press release states: "The stance of monetary policy has progressively shifted from an equal emphasis on price stability along with growth to one of reinforcing price stability with immediate monetary measures and to take recourse to all possible measures promptly in response to evolving circumstances."

Dear money policy

Since mid-2004, the RBI has been working towards a dear money policy, "in recognition of the cumulative and lagged effects of monetary policy."

The wholesale price index (WPI) has been ruling around 6.5 per cent for the third week running up to March 17; prices of primary articles, fuel group and manufactured products showed a year-on-year rise of 12 per cent, one per cent and 6.6 per cent as on March 17 against 3.7 per cent, 8.9 per cent and 1.7 per cent a year ago, respectively. The year-on-year growth in non-food bank credit has been put at 29.5 per cent as on March 16 against 32.7 per cent a year ago.

Deposits have moved up by 24.8 per cent as on March 16 over and above 18 per cent a year ago. Forex reserves have climbed by $18.6 billion from $179.1 billion (end-January 2007) to $197.7 billion as on March 23. The Market Stabilisation Scheme, to mop up rupees arising from purchase of dollars, has mopped up additional liquidity of Rs 23,894 crore between February 1 and March 23.

The RBI takes consolation in the fact that other central banks have been doing the same to hold back prices.

Firming up of crude prices at over $60 per barrel, supply-side discontinuities in farm goods and steep loan growth have together got the RBI to do a repeat of its actions since mid-2004.

In some ways, the RBI has no alternative other than marking up the repo and CRR rates as it has little left in its policy armoury. But the RBI has no say on farm supplies and bulging forex reserves adding to rupee funds.

In buying dollars, the RBI will be enhancing rupee liquidity; if it does not intervene in the forex markets, the rupee appreciates hurting exports. The central bank is in a bind not of its making.

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.