A beginner’s guide to language of the RBI monetary policy review and how it impacts your business
It is with much anticipation that the business community awaits the Reserve Bank of India’s annual statement on monetary policy, and the quarterly and mid-term reviews of the impact of the policy.
The RBI’s decisions on key policy rates—bank rate, repo rate and reverse repo rate—and cash reserve ratio (CRR) affect both corporate houses and big and small businesses alike. But how many do actually understand the impact of RBI’s policy announcements on interest rates and inflation? This year, the central bank announced its annual statement for 2007-08 on April 24, followed by its first quarter review on July 31, 2007. The mid-term review will be announced on October 30, 2007.
As RBI formulates and implements the monetary policy with the objective of maintaining price stability and ensuring adequate flow of credit to productive sectors, its outlook on the country’s GDP and inflation are closely watched by industry.
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The review
When RBI Governor Y V Reddy announced the first quarter review of its annual monetary policy for 2007-08 on July 31, he made it clear that the central bank’s first priority was to keep inflation under check rather than take measures to boost growth.
The rate of inflation is presently below 4% after having risen to a high of 6.5% in March this year.
“There is still a fear of high inflation in the minds of the public. We have to realize that inflation expectations have to be well-anchored in the country,” he said, releasing the policy.
The RBI hiked the CRR by 0.5% (50 basis points) to 7% while keeping repo rates and reverse repo rates unchanged.
Taming inflation?
According to T G Keswani of PHD Chamber of Commerce and Industry (PHDCCI), “the cut in CRR will help ease inflationary pressures.” The hike in CRR and the removal of cap on reverse repo transactions will remove excess money from the system, and is a clear indication that RBI is serious about following a tighter monetary policy. “Such a policy helps ease demand pressures and puts a check on credit growth and rising asset prices. This would help tame inflation,” says Keswani.
| DARE/rates | ||
| Bank | Wef | PLR (% |
| ABN Amro | 2/4/2007 | 15.25 |
| Bank of India | 13/4/2007 | 13.25 |
| Bank of Baroda | 5/4/2007 | 13.25 |
| Centurion Bankof Punjab | 10/4/2007 | 15.00 |
| Citibank | 26/2/2007 | 13.75 |
| HDFC Bank | 3/4/2007 | 15.00 |
| ICICI Bank | 31/3/2007 | 15.00 |
| Indian Overseas Bank | 16/2/2007 | 12.50 |
| Syndicate Bank | 16/2/2007 | 12.25 |
| Union Bank of India | 19/2/2007 | 12.25 |
| Source: Respective websites | ||
According to an impact analysis report by Crisil Research, “although the supply side inflationary pressure has eased in recent months, manufacturing inflation remains over 5%.” It goes on to say that a tighter policy stance, if successful, will check demand pressures, keeping a lid on credit growth and elevated asset price in the economy.
Lower inflation would provide industry the necessary competitive edge and may lead to lower production costs. Contrary to this, volatility in inflation derails long-term planning for businesses and budgeting becomes difficult leading to uncertainty about costs. Higher inflation also renders exports uncompetitive.
No rise in interest rates?
Although the central bank has raised CRR, analysts believe that businesses may rest assured that the net effect will not be a hike in interest rates. There are three reasons for this optimism:
(a) the interest rates are already on the higher side, and according to some experts, they have already peaked out
(b) though the hike in CRR drags out excess liquidity from the system, yet there is enough money floating with the banks. This may not prod banks to raise interest rates, and
(c) the RBI has left the crucial bank rate unchanged at 6%. This will encourage banks not to alter their prime lending rates (PLR)
In the usual course, RBI’s decision to hike CRR would result in commercial banks depositing more money with the central bank. This is turn sucks out excess liquidity from the market, which is at present close to Rs 1 lakh crore. The 0.5% hike in CRR will suck out around Rs 15,000 crore from the system.
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