New Delhi: In a “harsher-than-expected” move, the country’s central bank on Friday raised the cash reserve ratio by 75 basis points (bps), making a strong pitch for the government’s fight against rising inflation.
The CRR, or the portion of deposits banks are required to park with the apex bank, will be hiked in two stages -- 50 basis points from Feb 13 and another 25 basis from Feb 27 – from the present 5 percent, Reserve Bank of India (RBI) Governor D Subbarao told the chief executives of commercial banks here.
However, in a cautious move not to disrupt the money supply, the RBI left the key policy rates – repo and reverse repo – unchanged.
"As a result of this increase in the CRR, about Rs.36,000 crore of excess liquidity will be absorbed from the system," Subbarao added, as he presented the third quarterly update of the central bank's monetary policy for this fiscal.
Subbarao said the cut in excess liquidity will help anchor inflationary expectations and that the recovery process of the economy will be supported without compromising on price stability.
Harsher than expected
As inflation was steadily growing and the economy was slowly returning to higher growth trajectory, it was expected that the RBI would tighten monetary policy. But the 75-bps hike, according to investors, is a “more hawkish” move than many expected.
The market had expected and was prepared for a 50-bps hike. However, the central bank in a release issued on Friday said the action was necessary as the “rapidly rising” food inflation was putting pressure on other sectors as well.
“More recently, there are indications that the sustained increase in food prices is beginning to spill over into other commodities and services as well… With growth accelerating in the second half of 2009-10 and expected to gain momentum over the next year, capacity constraints could potentially reinforce supply-side inflationary pressures,” the release said.
The RBI has revised the inflation forecast for fiscal-end to 8.5 percent from 6.5 percent earlier. It has also revised the growth outlook to 7.5 percent for the current fiscal from 6 percent earlier, thanks to the fast-recovering industrial and services sector.
However, the GDP expansion in the third quarter is likely to be slower than that of the second quarter as the agriculture sector is struggling, the RBI said.
Loan growth is not up to the expectations during the fiscal and it was revised downwards from 18 percent to 16 percent.
End of cheap money policy
The RBI started loosening its grip over money supply in January 2009 by announcing a sharp cut in key interest rates in a move to help the battered financial market and struggling economy.
The central bank cut repo and reverse repo two more times – in March and April – to make money cheaper and step up the flow of cash in the system.
However, the bank was under pressure to tighten liquidity as inflation was rising and the latest move signals an end to the RBI’s cheap monetary policy.
’s headline inflation jumped to 7.31 percent in December, 2009 from 4.78 percent in November, mainly driven by high food prices.
Food price inflation rose to 17.4 percent for the week ended January 16 from 16.81 percent the week before. According to the government, the food inflation is a result of supply constraints and an erratic monsoon of last year and has nothing to do with the monetary policy.
But some critics say the excess liquidity in the system leads to building bubbles in the commodities which is driving up prices.
The government earlier this month has announced a slew of measures to fight inflation, including zero duty sugar inflation and enhanced allocation of rice and what for states. It has also urged state governments to take a tough line against hoarding.
First Published: Friday, January 29, 2010, 10:59