The Hindu Business Line : No escape from a CRR hike

Suddenly, growth worries have surfaced – serious enough for the Finance Minister to call corporate and bank chieftains for a meeting. Banks were asked to take a soft line on interest rates. They will not find it easy to agree. Their deposit costs are high and there are huge uncertainties about the Reserve Bank of India’s actions on the liquidity front.

The rupee’s continuing upward march is throwing several spanners in the works. Despite billions of dollar buying, the central bank is unable to stop the Indian currency’s rise. The RBI’s forex kitty grew more than $10 billion in the week ending Sept 28, pushing reserves to new records.

True, the liquidity arising from forex intervention is being mopped up immediately with MSS bonds, but the fiscal cost of this is becoming unbearable.

Servicing these bonds will add well over Rs 10,000 crore to Government expenditure.

The alternative is to open the reverse repo window. That too has its costs, but, at the first cut, will be to the RBI’s account, and, therefore, not immediately reflect in the fisc. There will be, of course, eventually an equivalent reduction in the RBI’s surplus distributed to the Government. Either way, the budget impact is the same.

Costless route

The costless route is obviously to increase the CRR. While this could be the preferred solution, it could force up lending rates as banks try to recover the loss of interest on CRR and is contrary to the desire of the Finance Minister to lower interest rates. The RBI will exercise its choice in the half-yearly review of Monetary Policy towards end-October. A CRR hike looks unavoidable.

Meanwhile, the villain of the piece – portfolio inflows – continues to be as strong as ever. With the stock market scaling new highs every day, the Government and the RBI are left with hardly any breathing room.

US factor

As forecast in last week’s column, US jobs data were strong, with substantial upward revisions to the anaemic figures of the last two months. This has significantly reduced the chances of another rate cut at the Fed’s next meeting at month-end.

But it is not as if the economy is completely out of the woods. There is still scope for a nasty surprise - not from housing, but (say) the collapse of a global financial institution. And even in the most favourable outcome, growth is likely to be modest – in the sub-3 per cent range.

Other US data of the last week confirm the ‘Goldilocks’ scenario of neither too hot nor too cold an economy, as should figures on retail sales and consumer confidence this week.

The minutes of the September 18 Fed meeting will be out on Tuesday and are likely to say that the 50 basis point cut is insurance. More rate reductions can, therefore, by no means be taken for granted.

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