RBI gives priority to growth over inflation

MUMBAI: RBI kept key policy rates unchanged on Thursday, signalling that maintaining growth momentum was a priority while taking steps to infuse close to Rs 50,000 crore of liquidity. This will ease pressure on banks to raise rates both on lending and deposits in the near term.

However, going by the hawkish tone of the mid-term policy review statement, the bond market is now bracing for a rise in interest rates in January when the next review is due. RBI has raised rates six times this year to fight inflation, and has warned that risk to its 5.5% inflation estimate in March is on the upside.

The mid-term review appeared to be more of a fire-fighting measure with attempts to pump money into the banking system, which saw a record deficit of Rs 1.44 lakh crore as reflected in bank borrowings from RBI on Thursday.

According to the apex bank, the deficit was making it tough for the banking system to sustain credit delivery.
RBI said although the liquidity crunch has helped achieve its objective by getting banks to raise rates, the shortfall was way outside its comfort zone.

Since the proposed infusion of Rs 48,000 crore through a bond buyback will make up for only half the average shortfall that local lenders face, bankers expect the deficit to continue in coming weeks.

However, they feel there will not be any pressure to hike deposit or lending rates for a few months. “There is no justification for banks to raise rates—deposits or lending—until March because measures taken by RBI will generate sufficient liquidity,” said RN Pradeep, CMD, Corporation Bank. According to Oriental Bank of Commerce Chairman TY Prabhu, while deposit rates will not go up further, the liquidity deficit will continue for a few months. Finance Minister Pranab Mukherjee said RBI’s decision will not adversely impact the inflationary trend. He reckons that the steps announced to buy government bonds will boost liquidity.

While there is nothing in Thursday’s policy review to prompt a fresh assessment of rates, some banks, which are yet to pass on the cost of higher deposits to borrowers, may do so after reviewing their base rate. “Base rates may need to be adjusted as part of the increase in deposit rates has not yet been transmitted to borrowers,” said Janak Desai, head of credit at ING Vysya Bank.

The measures announced on Thursday include a 1% reduction in statutory liquidity ratio (SLR) and a Rs 48,000-crore bond buyback. The cut in SLR—the mandated level of government securities that banks have to hold—does not impact liquidity much as a temporary reduction in this is already in force. However, it does make the cut in these mandated holding of securities an enduring one. Banks have been borrowing roughly Rs 1 lakh crore from the central bank daily. While the liquidity infusion is good for credit markets, there are indications that RBI may raise rates in the fourth-quarter policy review in January. Though inflation slowed to 7.5% in November, the central bank has placed an upside risk to its March ‘11 projection of 5.5%. The upward pressure on inflation is reflected in rising money supply and credit figures. But what appears to have emboldened the bank a bit is that asset-price inflation has taken a breather since its October monetary policy.

“RBI’s measures in its October policy, and the recent bribes-for-loans scandal has resulted in withdrawal of liquidity from realty developers. Prices have since softened and developers are now in a mood to talk (negotiate). They are offering freebies such as free parking, floor rise, and stamp duty payment. I expect prices to correct further around March as developers will be pressured to repay their loans rescheduled earlier,” said Knight Frank India Chairman Pranay Vakil.

Annual growth in money supply has been increasing over the past few fortnights. The annual growth in credit offtake is already higher at close to 23%, way above the central bank’s comfort level of 20%. However, deposit growth is still lower at 15%. “Overall, we see RBI remaining hawkish beyond today’s (Thursday’s) temporary pause, leading us to forecast a 25-bps hike in policy rates when RBI meets next on January 25,” said Taimur Baig and Kaushik Das of Deutsche Bank in a note to clients. According to B Prasanna, MD, ICICI Securities Primary Dealership, Thursday’s liquidity measures will soften the impact of a potential rate hike next month. “Because of today’s measures a rate hike will not unduly penalise the system. We feel that there is a 50% chance of a rate hike in January,” he said.

The liquidity infusion will ease the pressure on bond yields, which have been nearing two-year highs.