The next review of the credit policy for 2007-08 is expected on October 30. With moderate inflation, the expectations of a decrease in interest rates are high. Interest rates hikes for the past couple of years have put pressure borrowers. Recently, the Finance Minister had asked banks to take a soft line on interest rates. The wholesale price index inflation has come down significantly.
The growth in loans has moderated, and there is a slight rolling over in the economic activity. These are the desired outcomes of the tight monetary policy that the RBI has followed. As of now, the prime lending rate (PLR) of banks varies between 12.75 and 13.5 percent. Inflation is hovering around five percent. Other countries have substantially lower interest rates. China has a negative real interest of 2.64 percent. South Korea's real interest rate is three percent.
Thailand's is 1.45 percent and Malaysia's is 1.72 percent. The rupee's continuing upward march is throwing up problems for exporters. Despite billions of dollar of buying, the central bank is unable to stop the rise of the rupee against the dollar. The RBI's forex reserves are now more than $12 billion. The liquidity arising from forex intervention is being mopped up immediately with MSS bonds. However, the fiscal cost of this is becoming unbearable. Servicing these bonds will add well over Rs 10,000 crores to Government expenditure. The fund flows through the foreign institutional investor (FII) route has continued unabated.
The recent reigning in of the participatory note (PN) route may slow down the funds flow through this route. The surge in capital inflows has prompted the RBI to accelerate the pace of intervention in the foreign exchange market and the consequent scaling up of sterilisation through the market stabilisation scheme (MSS), restrictions on capital inflows through external commercial borrowing (ECB), the restricted use of PNs and liberalisation of capital outflows. Despite aggressive intervention, the rupee has kept appreciating. The issue of liquidity overhang continues to pose a challenge for the RBI in containing inflationary pressures.
All-time high global crude oil prices, global food shortages and the escalating domestic consumer price indices indicate a build-up in inflationary expectations. The enhanced MSS programme is also proving to be inadequate in absorbing excess liquidity meaningfully. The reverse repo auctions continue to attract large amounts of over Rs 300 billion.
The equity markets are demonstrating fair signs of resilience. FII inflows' share in accretion to forex reserves has averaged only 40 percent. So, a hike in the cash reserve ratio (CRR) appears inevitable. The CRR is a blunt and a direct instrument to impound liquidity to contain inflationary pressures largely emanating from higher than desired M3 growth. One alternative is to open the reverse repo window. This will come at a cost for borrowers. The other option is 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 the CRR. While taking a decision on whether to reduce interest rates or not, the RBI will be guided by the inflation situation and expectations. Global crude oil price hikes are going on. Crude has touched nearly $80. It is to be noted that high interest rates are taking a toll on the economy. The corporate sector is already feeling the pinch. There is a strong demand and visible case for reduction in interest rates.
The hard work done to control inflation has started yielding results. The RBI cannot afford to undo these efforts. The primary instrument which may be used to control liquidity in the system would be the CRR. This would draw out excess liquidity from the system. Also, with reduced funds, interest rates may not be brought down by the banks. On the contrary, they may have to stay at the present levels. An increase in interest rates is unlikely.
The growth in loans has moderated, and there is a slight rolling over in the economic activity. These are the desired outcomes of the tight monetary policy that the RBI has followed. As of now, the prime lending rate (PLR) of banks varies between 12.75 and 13.5 percent. Inflation is hovering around five percent. Other countries have substantially lower interest rates. China has a negative real interest of 2.64 percent. South Korea's real interest rate is three percent.
Thailand's is 1.45 percent and Malaysia's is 1.72 percent. The rupee's continuing upward march is throwing up problems for exporters. Despite billions of dollar of buying, the central bank is unable to stop the rise of the rupee against the dollar. The RBI's forex reserves are now more than $12 billion. The liquidity arising from forex intervention is being mopped up immediately with MSS bonds. However, the fiscal cost of this is becoming unbearable. Servicing these bonds will add well over Rs 10,000 crores to Government expenditure. The fund flows through the foreign institutional investor (FII) route has continued unabated.
The recent reigning in of the participatory note (PN) route may slow down the funds flow through this route. The surge in capital inflows has prompted the RBI to accelerate the pace of intervention in the foreign exchange market and the consequent scaling up of sterilisation through the market stabilisation scheme (MSS), restrictions on capital inflows through external commercial borrowing (ECB), the restricted use of PNs and liberalisation of capital outflows. Despite aggressive intervention, the rupee has kept appreciating. The issue of liquidity overhang continues to pose a challenge for the RBI in containing inflationary pressures.
All-time high global crude oil prices, global food shortages and the escalating domestic consumer price indices indicate a build-up in inflationary expectations. The enhanced MSS programme is also proving to be inadequate in absorbing excess liquidity meaningfully. The reverse repo auctions continue to attract large amounts of over Rs 300 billion.
The equity markets are demonstrating fair signs of resilience. FII inflows' share in accretion to forex reserves has averaged only 40 percent. So, a hike in the cash reserve ratio (CRR) appears inevitable. The CRR is a blunt and a direct instrument to impound liquidity to contain inflationary pressures largely emanating from higher than desired M3 growth. One alternative is to open the reverse repo window. This will come at a cost for borrowers. The other option is 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 the CRR. While taking a decision on whether to reduce interest rates or not, the RBI will be guided by the inflation situation and expectations. Global crude oil price hikes are going on. Crude has touched nearly $80. It is to be noted that high interest rates are taking a toll on the economy. The corporate sector is already feeling the pinch. There is a strong demand and visible case for reduction in interest rates.
The hard work done to control inflation has started yielding results. The RBI cannot afford to undo these efforts. The primary instrument which may be used to control liquidity in the system would be the CRR. This would draw out excess liquidity from the system. Also, with reduced funds, interest rates may not be brought down by the banks. On the contrary, they may have to stay at the present levels. An increase in interest rates is unlikely.
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