RBI likely to raise rates amid liquidity crunch

By Manju AB Oct 31 2010 , Mumbai

Despite liquidity crunch, the Reserve Bank of India is expected to raise key short-term

interest rates by at least 25 basis points on Tuesday to control inflation, which is still ruling high at 8.62 per cent.

But the RBI may leave the portion of net assets and liability that banks have to park with the central bank, or cash reserve ratio, untouched at 6 per cent. The central bank will find it difficult to balance growth, temper inflation and maintain liquidity.

“The RBI will continue with gradual easing so that monetary transmission is faster and banks will raise deposit rates more aggressively. Deposit growth of banks has been slower than credit growth and inflation continues to be at elevated levels. Liquidity tightness was only a temporary phenomenon. By the middle of next week, the system will have enough liquidity with money coming back from Coal India IPO and SBI bond issues,” said a senior official of State Bank of India.

The RBI has been expressing its unhappiness with banks for not adequately raising rates to match money policy tightening. One-year deposit rates of most banks still stand between 7.5 per cent and 7.75 per cent, leading to negative interest rates for depositors.

This is forcing people to invest in stocks and other asset classes, including real estate, said bankers.

The Coal India IPO, which was oversubscribed 24 times, sucked out Rs 236,113.28 crore, of which Rs 220,113.28 crore will be debited to the accounts of those who were not allotted shares. Another Rs 10,000 crore collected for the SBI retail bond issue will also be debited back to applicants who did not get the bonds.

Data collated by IDBI Gilts show that deposits have been growing at 15.07 per cent, lower than the 19.95 per cent in the same period last year, and it is also falling below the RBI’s projected growth rate of 18 per cent.

The growth in non-food credit is also about 20.07 per cent, which appears to be robust compared with 11.8 per cent a year ago. But after adjusting for 3G and BWA, the current growth falls to 18 per cent.

“Sluggish deposit growth will be one of the triggers for RBI to opt for hardening of interest rates. Though food price inflation is cooling off and the kharif crop has been good, RBI will intervene to be ahead of curve so that they will achieve the inflation target of 6.5 per cent by the end of the financial year. The IIP numbers also have been erratic, so it is a fine balancing act,” said Ashutosh Khajuria, head of treasury, IDBI Bank.

The latest index of industrial production shows a growth of just 5.6 per cent, much lower than the 12 per cent in July, with decline coming from capital goods, raising doubts about industrial capacity formation.

Also, liquidity shortage in the system is so acute that on Friday banks borrowed Rs 131,000 crore, the highest ever from the repo window of the RBI, after which the central bank opened the second liquidity adjustment facility (LAF) window in the afternoon and reduced the portion of deposits banks have to invest in government bonds, or statutory liquidity ratio (SLR), by 1 per centage point for two days.

LAF window is the corridor provided to banks by the RBI to either borrow money through the repo window or deposit cash through the reverse repo window for effective liquidity adjustment.

After the RBI opened the second LAF window, banks borrowed only Rs 350 crore. “It was ineffective liquidity management as most banks had borrowed in the morning and call rates shot up to 13 per cent. RBI needs to implement new tools to manage liquidity in the banking system,” said bankers.

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