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Money just got pricier! - Views on News from Equitymaster
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Money just got pricier!
Feb 14, 2007

The RBI has raised the CRR (effective in two tranches) within a month of the last 50 basis point (0.5%) hike spread over December 2006-January 2007 from 5.5% to 6% of the net demand and time deposits of the banking sector. As India’s central bank, the RBI has had two issues to tackle: firstly, too much credit was flowing into building of ‘unproductive’ assets – retail and real estate. Secondly, the continued interest of the rest of the world in India and a fiscal policy that has put more money into the hands of people rather than build assets (revenue expenditure of the central government accounts for 12% of the GDP while capital formation got 2% in FY07), has seen money supply grow by 21% YoY in January 2007, up from the 16% YoY 12 months ago.

Despite the RBI raising the rate at which the banks borrow from it by 100 basis points over the last 9 months, the markets are flush with funds: call money rates actually fell after the last hike in repo rates on January 31, 2007. Foreign Direct Investment has doubled, NRI deposits have increased five-fold, and though the FIIs have bought less this year, their flow is US$ 1.5 bn positive. Banking sector assets have grown by 55% over January last year.

After lying low within the 3% to 5% range for almost 20 months, headline inflation as measured by the Wholesale Price Index (WPI) has shown a brisk increase to 6% plus levels since the beginning of 2007. But the ‘more-in-the-background’ Consumer Price Index for Agricultural Labourers has shot up from 4.7% in January 2006 to 8.9% in January 2007. Majority of this inflation is related to the higher prices of food products. Comparatively, food articles are just 15% of the WPI and have grown at 10% YoY in January 2007. Going forward, we expect prices of manufactured goods (64.8% weightage in the WPI) inching up slowly at 6.2% in January 2007, to move up to around 9% to 10% over the next six months, pulling up the WPI further into the 7% to 8% range.

The supply shocks on the agricultural production front need to be tackled more decisively. The government yesterday banned wheat exports, a measure that probably should have been undertaken 3-4 months ago. If the government had better managed its stocks – as yet in FY07, wheat procurement is 36% lower and the Public Distribution System (rationing) off take is 5 m tonnes as against 8 m tonnes in FY06; the open market prices of wheat would have been more stable. All these have added to the inflationary pressures.

By raising the CRR, the RBI hopes to contain the growth in money supply as well as squash inflationary expectations that can be at times more damaging than the actual increase in prices. As the medium term and long term lending rates are yet to be moved, the impact of interest rates on expected growth would not be severe. The RBI has not yet taken recourse to the ‘bank rate’ (that currently stands at 6%) – only a concerted effort on the central government’s part to reduce its revenue expenditure and a significantly increased capital outlay in the coming budget would be a signal for happier times.

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