What the doctor ordered

In its mid-quarter review of monetary policy, the RBI has made it clear that it is likely to persist with the current anti-inflationary stance. The central bank's move reflects its concern over the rising inflation numbers, particularly in manufactured products, which has spurted from 3.75 per cent in January to 4.94 per cent in February, though WPI inflation rose only marginally from 8.23 per cent to 8.31 per cent.

Since the pass-through of higher crude oil prices has not been effected, there is potential danger for inflation to rise further in the coming months, and thus the rate hike was appropriate.

POLICY IMPACT

The RBI has been raising key policy rates over the last 15 months in a bid to control inflation, while ensuring that growth is not halted. However, if the policy rate hikes are not transmitted, these efforts will not bear fruit. The regulator will be forced to increase the rate hike to achieve the desired objective.

Hence, one can expect the interest rates charged on personal loans, housing loans and auto loans to go up in the coming weeks. So far, banks have been able to successfully pass on the higher cost of funds to the borrowers, who have also recovered it from consumers. It is only when the pass-through becomes impossible that the rate hikes will halt.

Banks' deposit rates have increased by 200-250 basis points over the last few months. It is quite possible that banks may not rush to increase the interest rates on deposits and postpone the decision to the next financial year. It is widely anticipated that banks, after witnessing a sharp shrinkage in their net interest margins in the last quarter of the current financial — and with estimates of a further erosion in margin next year with more deposits getting re-priced on maturity — will not increase their funding costs without testing their success with higher rates on lending. Since the year-end pressures are under control, banks will take their own time before deciding any increase on deposit rates.

LIQUIDITY SITUATION

The RBI feels that liquidity management is comfortable so long as the surplus or negative liquidity is plus or minus 1 per cent of Net Demand and Time Liabilities of banks, effectively working out close to Rs 50,000 crore. After the advance tax outflows on March 15, the liquidity in the system is negative to the extent of Rs 1.17 lakh crore. However, once the reverse flow of the money from the government into the system starts, there will be an improvement in the liquidity conditions.

The schedule for Govt borrowing for the FY 2012 is slated to be announced on March 25. There is unlikely to be any extraordinary pressure on liquidity, with government matching its spending and borrowings.

With the lending activity to slow down in the coming weeks and banks getting a normal flow of deposits, liquidity in the system will not come under any strain, or be a huge surplus. In either case, the RBI will intervene and keep the position within the plus/minus 1per cent band of the NDTL of banks.

(The author is MD and CEO, City Union Bank.)

COMMENT NOW