RBI's repo rate, CRR hike set to make loans dearer, hurt investments
Sacrificing economic growth, India's central bank, the Reserve Bank of India's (RBI) hiked the repo rate, or the key lending rate at which the central bank lends funds to commercial banks, and the cash reserve ratio (CRR) or the proportion of reserves the commercial banks must keep with the central bank, to 9 percent each on Tuesday to tame inflation.
Though RBI has cited high inflationary pressures as the prime reason behind its decision to hike repo and CRR rates, yet, analysts suspect the apex bank also acted in response to "strong credit growth" despite several monetary and prudential measures taken by it. And, this suspicion is not unfounded, especially, in the light of RBI Governor Y.V. Reddy's statement on the First Quarter Review of Annual Monetary Policy for the Year 2008-09.
"Since April 2005, the Reserve Bank has been expressing concerns about strong credit growth, the significantly overdrawn state of the banking system to sustain the credit disbursement, mismatches between sources and uses of funds and implications for interest rates, liquidity conditions and credit quality. Several monetary and prudential measures have been undertaken in this period and banks have been sensitized in this regard. While there has been some rebalancing and overall correction during 2007-08 in response to policy initiatives, in 2008-09 so far, however, some banks have expanded credit rapidly in relation to the system level growth, with attendant worsening of their credit-deposit ratios," Reddy said.
"These developments warrant heightened policy concerns in the interest of overall systemic stability and the quality of financial intermediation. In this context, banks are urged to review their business strategies so that they are in a position to combine longer term viable financing with profitability in operations, recognizing the reality of business cycles and countercyclical monetary policy responses," he said.
"A key aspect of this review should be a renewed emphasis on credit quality while simultaneously pursuing greater credit penetration and financial inclusion. Banks should focus on stricter credit appraisals on a sectoral basis, monitor loan to value ratios and generally ensure the health of credit portfolios on a durable basis without encountering undue asset-liability mismatches. If necessary, the Reserve Bank would consider undertaking supervisory review of those select banks which are over extended in terms of their credit portfolios relative to their sources of funds," he added.
Following RBI's move, commercial banks are expected to increase their prime lending rates (PLRs), which would make loans across all segments become dearer. The banks are also expected to increase deposit rates.
Market analysts said RBI's move was a double whammy for banks as it means a direct increase in fund cost while liquidity is being squeezed.
"RBI has been pre-emptive in hiking repo rates and we do not expect further repo rate increases," said Sonal Varma, economist at Lehman Brothers in Mumbai.
"However, CRR hikes will continue in order to ensure that tight liquidity conditions remain," he said.
According to Varma, RBI's message is clear: "Demand slowdown is required to curtail inflation."
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