RBI may hike reverse repo rate

RBI Governor Y V Reddy is widely expected to hike overnight borrowing (reverse repo) rate in the third quarter review of credit policy on Wednesday, as he sets out to tackle inflation without hurting economic expansion and stoke farm sector growth.

In its macroeconomic and monetary development report released ahead of the review, RBI has admitted to inflationary pressures, raising speculation of hardening of interest rates.

But it will have to consider whether hike in interest rates could hurt the manufacturing and service sectors presently pushing the economic growth. Bankers are gearing for a rise in repo (lending) and reverse repo rates, besides tight norms for housing and retail loans.

Finance Minister P Chidambaram has hinted that after fiscal measures taken by the government, RBI will have to take monetary steps to curb inflation, which touched a two-year high of 6.12 per cent in the first week of January before easing to 5.95 per cent the following week.

In fact, it is not the high international crude oil prices, but supply constrains in agriculture and certain manufacturing sectors that have led to rise in prices.

"RBI should ensure adequate lending to the agriculture sector at reasonable interest rate, if it wants to address the growth and inflation issues," said Chengal Reddy, secretary general, Consortium of Indian Farmers' Associations.

He said the country would not have faced 30-40 per cent rise in prices of foodgrains, vegetables, pulses and fruits, had the RBI and government addressed the agriculture crisis. 

The central bank also admitted that prices of primary food articles and manufactured products posed upward pressure on inflation, which was 6 per cent by mid-January as compared to 4.1 per cent in end-March, 2006.

Bankers admit that although RBI had announced in October 2006 that banks would come up with one-time settlement scheme for distressed farmers, the sector is still awaiting it.

However, with growth in tax revenue and government's assurance to meet fiscal deficit targets, RBI can announce measures to ease the flow of capital, and industry's demand to raise funds from abroad.

Meanwhile, rating agency Standard & Poor's raised India's sovereign credit rating to investment grade for the first time in 14 years, which is expected to encourage investment flows. The finance ministry is also expecting initiatives by RBI to utilise forex reserves, especially for infrastructure sector.

ABN Amro Bank's chief economist Abeek Barua said, "We are expecting increase in repo and reverse repo rate by 25 basis points, coupled with marginal reduction in floor ceiling of 25 per cent on statutory liquid ratio to meet liquidity demand."

While a hike in borrowing rate would encourage commercial banks to park money with the RBI, leaving them with less for lending, a hike in the key short-term lending rate would increase the cost of loans from banks.

The industrial sectors reminded that instead of merely hiking interest rates to curb inflation, the regulator should ease the flow of funds to sustain the growth rate, apart from measures to increase supply in the agriculture sector.

With non-food credit surging to 31.2 per cent in 2006-07, and deposits growing to 22.5 per cent, RBI may find it hard to slow down the demand for credit by merely raising interest rates, especially in the housing sector, they said.

The Monetary and Credit Policy 2006-2007