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Monetary Policy: RBI doesn’t give up

Jul 29, 2008

In its uncompromised efforts at anchoring the inflation to tolerable levels and restrict the growth of credit to keep default rates low, the Reserve Bank of India (RBI) has once again struck hard with its monetary policy tools to tame the flow of money in the economy. So much so that this has brought the benchmark cash reserve ratio (CRR) and repo rate at their decade highs. In its first quarter review of the monetary policy for 2008-09, the RBI has effected a 50 basis point (0.5%) hike in the repo rate (rate at which RBI lends to banks) and a 25 basis point (0.25%) hike the cash reserve ratio (CRR), which leaves banks with lesser cash to lend. The CRR post this hike at 9% is at a 12-year high while the repo rate post this hike also at 9%, is at nearly a decade high. Not mincing words with what the RBI intends to do, the policy statement clearly states and we quote, "While the policy actions would aim to bring down the current intolerable level of inflation to a tolerable level of below 5.0% as soon as possible and around 3.0% over the medium-term, at this juncture a realistic policy endeavour would be to bring down inflation from the current level of about 11.0-12.0% to a level close to 7.0% by March 31, 2009."

At a time when the RBI is being criticised for putting a brake on India's growth engine, the central bank seems confident enough of choosing the correct stance. It has revised the GDP growth estimate for FY09 from the range of 8% to 8.5% to just 8%. The report on 'Macroeconomic and Monetary Developments' released yesterday already shows that the growth of the most important components of IIP (Index of Industrial Production) have nearly halved in the first quarter of this fiscal. The manufacturing sector recorded growth of 5.3% YoY (11.8% YoY last year) while the electricity sector recorded growth of merely 1.7% YoY (9.0% last year). The infrastructure sector recorded growth of 3.5% (6.9% last year) reflecting deceleration in all the sectors except coal and crude petroleum.

While there are early signs of some moderation in money supply and deposit growth as well, the RBI has expressed its discomfort with the fact that the credit growth (25.9% YoY in 1QFY09) continues to remain above the indicative projections, thus warranting continuous vigilance.

While not completely unanticipated, this measure by the RBI will put further strain the funding costs of banks that are already trying hard to sustain their net interest margins (NIMs). Also, corporate and retail borrowers alike are expected to defer their borrowing plans to avoid the high rates. For investors, we do not see a plausible reason to change their investment decision based on this premise as these are temporary measures and unlikely to have any adverse impact on the fortunes of companies with strong fundamentals.

  • Also read - Our view on the 1QFY09 results of banking companies


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