The Hindu Business Line : Reverse repo rate hike: A pre-emptive strike by RBI

The latest data seem to bear out the RBI's fear about increasing inflationary pressures in the economy which had prompted it to hike the reverse repo rate by 25 basis points to 5 per cent in the Annual Policy.

At this point of time, the reverse repo rate increase must be seen more as a sort of pre-emptive strike than the beginning of a series of upward moves.

Among the major central banks of the world only the US Federal Reserve seems to be on a prolonged ascending path of interest rates. The Bank of Japan is likely to be hold zero rates for a lot longer given the stream of anaemic data recently emanating from the economy. And the ECB will derive scant comfort from the slew of weak indicators on the German and other euro-zone economies.

Even the noises of the Bank of England have lately been subdued following a noticeable slowdown in house price inflation and a string of bad retail sales numbers. The likelihood of a near-term rise in the UK's rates is pretty remote.

For RBI, much will depend on the path of oil prices in the coming months. The other critical factor is the behaviour of the monsoon. If these two variables do not add to the potential for higher inflation, the WPI will peak in the current range. That would enable the RBI to contain the reverse repo rate to the current level of 5 per cent.

Figures from the banking system show impressive growth on the credit front. But liquidity continues to rule easy judging by the tens of thousands of crores still moving into the RBI's vaults in the daily reverse repo auctions.

It appears the increase in banks' loan assets will not exert upward pressure on interest rates. Indeed a situation could arise when the central bank is hard put to keep money market rates from dipping below the reverse repo rate.

Of course, the Government's borrowing programme as well as the new weapon of market stabilisation bonds will countervail the downward pressure on call rates.

If oil does continue to rule high, the forex deficit will rule out the necessity for the RBI's dollar support operations, thereby withdrawing a significant source of market liquidity.

Yield levels in the range of 7.25-7.50 per cent for 10-year gilts offer a spread of 2.25-2.5 per cent on overnight rates. They look even more attractive for shorter maturities of five years, if indeed the RBI does not see the need to become aggressive on the monetary and interest rate fronts.

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