RBI tightens credit off take, deposit rates to go up

BILAL HUSSAIN

The Reserve Bank of India (RBI), central bank, on Thursday took a step of hiking the key short-term lending rate which is expected to contain the rising inflation. Bankers here believe that the move is expected to raise the deposit rates.
The repo rate, the rate at which our banks borrow rupees from the central bank, is raised by 25 basis points (bps) to 6 per cent and reverse repo rate, rate at which RBI borrows money from the banks, has been hiked by 50 bps to 5 per cent with immediate effect.
The decision has been guided by the need to contain inflation, which is currently at 8.5 per cent (food inflation has touched 15.10 per cent), as a hike in rates will lead to a rise in cost of funds for banks and will make loans expensive. This, in turn, will reduce consumption.
While another banker said, "Till September 30 most of the banks would hold on to the interest rate. After that there might be a pass on effect to customer."
The RBI wants deposit rates to go up as there is a need to make the real interest rates, the difference between inflation and deposit rate, positive. "Real interest rates need to move in the direction of encouraging bank deposits", the central bank said. While a private local banker here said, “Rate of interest may have to go up. Banks have to take a view at the end of the quarter.”
The RBI estimates the growth in Q1 of 2010-11 at 8.8 per cent. “Although some of this is attributable to a favourable base effect, the growth rate indicates that the recovery is consolidating and the economy is rapidly converging to its trend rate of growth,” RBI said.
According to the central bank the index of industrial production (IIP) showed some slippage in the last month of the quarter (June 2010) with the revised numbers showing growth to be a relatively sluggish 5.8 per cent. The trend was sharply reversed in July, with growth surging to 13.8 per cent, led by capital goods, which grew by 63 per cent. Although the year-on-year growth rate for the first four months of the year remains robust at 11.4 per cent, the high volatility over the past two months raises some doubts about how effectively the index reflects the underlying momentum in the industrial sector.
The growth prospects in agriculture according to the RBI have clearly been boosted by the monsoon, which, by virtue of substantial replenishment of reservoirs and ground water, will also contribute to a good rabi harvest. Virtually all leading indicators of service sector activity point to sustained growth.
However, the inflation remains the dominant concern in macroeconomic management. The published wholesale price index (WPI) inflation rate for August 2010 was based on the new series (base year: 2004-05=100) for the first time. The new series has better coverage of items and the manufacturing products group has a slightly higher weight. Both the old and the new series, however, indicate similar broad trend of inflation. For instance, average monthly WPI inflation for Q1 of 2010-11, based on either series, is in double digits.
However, the monthly average of WPI inflation for Q1 of 2010-11 under the new series at 10.6 per cent was about 50 basis points lower than the rate of 11.1 per cent under the old series. In July 2010, there was a slight moderation in the provisional WPI inflation under both the series. There has been further moderation in the provisional WPI inflation to 8.5 per cent in August from 9.8 per cent in July 2010 as per the new series. The direction of the inflation rate movement is consistent with the Reserve Bank’s projection made in the July review, though the magnitude could be slightly different. “There is, therefore, need for continued policy response to contain inflation and anchor inflationary expectation,” RBI said.
With reference to government finances, the fiscal deficit appears to be conforming to the estimates made in the Union Budget for 2010-11. “Higher than expected realisations on 3G and broadband wireless access (BWA) auctions combined with buoyant tax revenues have virtually eliminated the risk of the fiscal deficit overshooting the targeted 5.5 per cent, even after the supplementary demand for grants is taken into account. This will help stabilise market expectations of liquidity and interest rate movements,” the central bank said.