INDIA BUSINESS WORLD – FEBRUARY 2007
The Month that was ...

GOVT, RBI GO ALL OUT TO TACKLE INFLATION

The past week saw an all-out effort from the Union government and the Reserve Bank of India to rein in runaway prices which pushed annual inflation rate to 6.73%.

The government and the apex bank took a series of measures to curb inflation and squeeze liquidity in the banking system which has resulted in overheating in certain sectors of the economy.

The Reserve Bank of India announced a 50 basis points increase in the cash reserve ratio (CRR) the slice of customer deposits that banks set aside as cash from 5.5% to 6%.

The measure, to come in two doses 5.75% from February 17 and then 6% from March 3 will impound Rs 14,000 crore from banks, which will now be left with less resources to lend from.

The week also saw the government reducing prices of petroleum products. Petrol prices were cut by Rs 2 and diesel was made cheaper by Re 1. This measure is expected to bring down the prices of foodgrain and vegetables carted across the country.

RBI has justified the move in view of the paramount need to contain inflation expectations and in the light of the current liquidity conditions.

On December 8 last year, RBI had stunned the market with a half-a-point increase in CRR to 5.5%. The decision will further harden interest rates across products, spring a nasty surprise on financial markets like stocks and bonds, and may even cool down spiralling property prices.

Although the move is aimed at curbing inflation, experts believe that inflation may actually inch up if the government, which has largely refrained from spending, decides to spend in the last quarter. Though the central bank had warned the market that a CRR hike cannot be ruled out, banks continued with their lending and many bond market traders felt that the worst was over.

Banks and bond players, however, are upset with the timing of the two CRR hikes. Since both hikes came immediately after RBI, as banker to the government, completed two sets of government bond auction, banks and bond houses which had invested in the auctions had to take a hit. For some of the bond houses, the hikes will wipe out their last 10-month earnings.

Also, buying a home or a car or seeking a personal loan for an overseas trip in the coming summer may now pinch you a lot more than what you had expected. Now most bankers feel that it is imperative that lending rates will shoot up further, by another 25-50 bps at least.

Home loan rates may go up as banks will now charge us higher rates. But the housing prices are high because of supply side constraints. An increase in rates would not deter genuine home buyers, but investors would keep away.

ICICI Bank, which recently announced a 100 bps hike in its prime lending rate and home loan rates, is expecting a slowdown in consumer credit on account of the rapidity at which the rate hikes have been announced. That borrowing from genuine home buyers as against investors is likely to continue. A 100 bps increase in lending rates raises the equated monthly installment on a 20-year Rs 10 lakh loan by Rs 700.

In another related development, the Reserve Bank asked banks to check whether the money lent to traders is used to hoard food grain. Banks have been asked to review the records of their top borrowers both companies and NBFCs.