The Hindu Business Line : Expect status quo in credit policy review

LAST week, Dr Y.V. Reddy, RBI Governor, said that the central bank can sometimes lead and sometimes follow commercial banks with regard to interest rate increases. He was commenting about the pre-emptive hikes in interest rates by some banks, ahead of the credit policy review scheduled for January 24.

What he may have left unsaid is that central bank may also exercise the option of simply sitting still. That he will stick to status quo, after stacking up points in favour of various courses of action, is what quite a few bankers seem to expect from the review.

The main concerns that emerged during the past year remain. Rising oil prices continue their course. Crude oil prices are at close to $69/barrel today compared with about $62 three months ago. Higher inflation could be a consequence, giving rise to expectations of higher interest rates.

Besides, loan growth continues to outpace deposit growth by almost 2:1. Liquidity in the system has been under pressure over the last month as a huge quantum of deposits of about Rs 31,500 crore raised by SBI under the Indian Millennium Deposits (IMD) was repaid. Call money rates (rate at which banks lend money to each other overnight) are hovering at close to 7 per cent currently and have averaged 6.5 per cent during the past month. The Reserve Bank of India has pumped in an average of Rs 20,000 crore daily through its repurchase rate auctions. Some banks have also increased their deposit rates by about a quarter per cent. And the amounts raised by banks through certificate of deposits (CDs), a window of borrowing from other banks, (seldom used in the past,) has risen to Rs 32,806 crore compared with Rs 15,000 crore in April 2005.

As for lending rates, banks have been put in a difficult situation, since the Finance Minister has requested a temporary freeze on any hike. But the closest official indication that a hike has happened is seen from commercial paper (a cheaper form of borrowing for top-rated corporates) rates. Interest rates have jumped by one percentage point over the past six months to hover around 6.5 per cent currently at the lower end.

So what can the Governor do? One — cut the cash reserve ratio (the amount of cash deposited with the RBI by banks) from 5 per cent (of deposits) to about 4.5 per cent. That may free about Rs 10,000 crore. This is, however, likely to be only a temporary palliative considering the kind of borrowing demands being made.

Two — raise the RBI's lending rate to banks. This can be done, either by raising the repurchase rate or repo rate from the current 6.25 per cent, or increase the bank rate, (at which most of the RBI's refinance facilities for banks are available) which is currently at 6 per cent. That may, however, not happen, given the higher cost that it will imply for both corporate and government borrowing. With the Budget just over a month away, the RBI may want to wait a while.