Repo hike won't tame inflation
The RBI has hiked the repo rate by 25 bps after almost 18 months. The decision was taken even before the fuel price hike made its impact on inflation, suggesting inflation may be worse than expected.
By ET Bureau |
The RBI has hiked the repo rate by 25 bps after almost 18 months. The decision was taken even before the fuel price hike made its impact on inflation, suggesting inflation may be worse than expected. Whether the rate hike really has any bearing on inflation and inflationary expectations or will just hurt growth is a crucial question.
Repo is the rate at which banks borrow from RBI. So, a repo hike means costlier borrowings. So far, banks had comfortable liquidity despite the recent 75 bps CRR hike. It was clearly revealed in the average amount parked by banks under reverse repo, cash balances of commercial banks and call money rates during April and May.
Till May 23, an average of Rs 24,000 crore was absorbed on a daily basis under reverse repo auctions against a daily injection of Rs 20,000 crore in the last fortnight of March, which was the time of liquidity crunch. Moreover, surplus bank balances had risen over Rs 39,00,000 crores for the fortnight ended May 23, compared to balances at Rs 35,00,000 crore at the end of March. The average call money rate in the past two months was 5-6% below repo rates, implying adequate liquidity in the system till the first half of May.
Though liquidity has tightened in the last week of May due to RBI���s MSS auctions and the rollout of the last tranche of CRR hike, liquidity conditions are expected to turn normal soon. No change in overall money supply despite hike in CRR, lower demand for credit and sustained rise in deposits ensure comfortable liquidity for banks. If liquidity is comfortable, banks may not tap repo auctions in the near future. And if banks are unlikely to use this option, the repo rate may have minimal impact.
With these instruments, RBI may adjust liquidity in the banking system, but it may not have a direct impact on people���s preference for cash balances. Currency with the public, which accounts for almost 15% of the total money supply, recorded an annual growth of 19.6% as on May 23, 2008, higher than the 15.5% rise, a year ago.
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This determines spending capacity: Higher spendings lead to higher demand, pushing prices up. If the currency in circulation increases, how will monetary measures address the issue of inflation? Rather it will just raise interest costs for India Inc, putting pressure on margins and adversely affect their production and capacity expansion plans. In short, the repo hike will have no major impact on containing inflation. But, it has definitely signalled that RBI is closely watching inflationary movements and will adopt stringent measures like reverse repo rate hike, if needed.
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