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What do bankers read into RBI�s credit policy?

Published on Tue, Apr 29, 2008 at 13:31 | Source : CNBC-TV18

Updated at Wed, Apr 30, 2008 at 10:17

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YV Reddy, Governor, Reserve Bank of India

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Reserve Bank of India Governor YV Reddy has done it again. He has hiked the Cash Reserve Ratio, or CRR, which is the funds that banks have to park with the central bank, by 25 bps to 8.25%. Contrary to most market expectations, he has left the repo, and reverse repo rates unchanged.

So, what do bankers and economist read into Reddy speak?

KV Kamath, Managing Director and CEO, ICICI Bank , said the CRR hike is likely to suck out about Rs 8000 crore from the system. He feels the hike will not impact the banking sector significantly. "We need a supply side response to contain inflation."

Kamath feels there is need for a supply side response to tackle inflation.

Abheek Baruah, Chief Economist, HDFC Bank , doesn't see an across the board increase in the prime lending rates but in some select categories where banks perceive pricing power or where they want to reduce exposures. "Demand conditions in the credit market do not warrant an across the board increase in lending rates by banks because credit demand is dwindling and there is genuine downward pressures in categories like retail credits. So, they will perhaps go and hike the effective lending rates."

He feels the clear emphasis now is on liquidity and M3. "The best way to get this down is to keep sort of increasing the reserve ratio and that's clearly the tack at this stage. It is reasonably hawkish but not hawkish beyond a degree. It could have been far more aggressive on the inflation front using perhaps a combination of both CRR increase and a repo rate hike. So, it clearly does factor in some growth concerns but doesn't entirely sort of give in to the needs of growth and keep an eye on inflation."

Ajay Mahajan, Group President-Financial Market, Institution and Investment Management, Yes Bank , feels the CRR hike could result in liquidity in the system getting pressured in the wake of the upcoming government bond auctions as well as the spiraling oil pool deficit account, which would lead to far significantly higher oil issuances. "The market would continue to expect further tightening measures given that the repo rate hike has not come through."

He sees more policy action from RBI going forward. "The CRR hike will effectively mop away the excess liquidity created as a result of foreign exchange intervention of about USD 2-3 billion in the preceding period last week. "I feel moderate liquidity conditions would be allowed to prevail in the wake of rising inflation. That is the first thing that RBI will probably focus on. If not repo rate hikes we are certainly going to see more CRR action going forward, given that the foreign exchange flows in the country have been fairly strong."

According to Mahajan, the CRR hike will shave off 10 bps from the banks' bottomline.

Nilesh Shah, Deputy MD, ICICI Prudential , said the hike would certainly put pressure on banks' ability to price their lendings. "Since they haven't been revised for almost an 75 bps hike, probably there is a need to tinker around a little. However, since the repo and the reverse repo have been kept unchanged, maybe some banks will probably take a call based on their asset liability mismatch and that there is no need for revision. So, it's not going to be a consensus decision as some banks may raise interest rates while others might decide not to raise interest rates."

Ajay Shah of IGIDR , or Indira Gandhi Institute of Development Research, also shares Ajay Mahajan's view. He feels a 75 bps cut will shave 10 bps off the banks' P&L. "However, it won't rein in inflation. To politicians, it is really important for the UPA to bring inflation back under control in time for elections, so it leaves the big question dangling as to how are we going to get inflation back under control."

Shah feels that only a rupee appreciation can materially impact inflation in time for the next elections.

Arun Kaul, GM-Treasury Finance, PNB , said RBI had not given any indication on the hike in interest rates. He feels the CRR hike was prompted by higher money supply than what was anticipated by RBI. "As against the budgeted 17-17.5%, actual money supply has been 20-21%. Now, they want to bring it back to 17%. Inflationary expectations could be controlled. So, clearly the focus of RBI is on inflation control and reducing liquidity."

He feels it will be premature to say whether this would adversely affect the banks in terms of deposit cost. "We will have to wait and see how cost of deposit shapes up and is there a need to pass the burden to the consumer or not."

Hitendra Dave of HSBC India said RBI's focus is very much on the short-term and the CRR hike is a reflection of that. "Their continuing focus on liquidity that they may do something more also on the CRR front, would seem to suggest that it is going to be on liquidity rather than on rates."

Ashish Parthasarthy, Head-Trading, HDFC Bank , said the inflation issue cannot get resolved overnight. "To my mind, the policy is trying to curb liquidity by trying to manage M3, which has been higher than target, so that the contribution of excess money to inflation gets reduced."

According to Parthasarthy, the fact that RBI has left rates untouched is indicative of the view that interest rates are reasonably high and need not be hiked further at this point in time. He doesn't see PLRs going up.

OP Bhatt, Chairman, State Bank of India said, " The CRR hike will suck some liquidity out of the system. The RBI continues to be mindful of inflation and they have balanced the act between growth and inflation excellently."

Chanda Kochhar, Joint MD of ICICI Bank sees many other positive signals in the policy. She said, "If you see clearly we are saying that the growth rates are and are going to be between 8-8.5%. There is a clear signal here that the growth rates are expected to continue at above 8%. If one reads further, it clearly says that the credit growth is positive because if we read in the details, the credit growth on the services sector and the industrial sector has been very robust."

According to her, the signal is that as a country certain priorities growth is one priority and the momentum of investments currently continues to stay and as long as the focus is on that, we would as country ensure that the growth is here to stay.

On CRR, she said, "Clearly there is a very big indication here in the policy statement to say that henceforth monetary policies will concentrate on liquidity management and the interest rate decisions will be left to the banking sector and to the banks. This is clearly what the policy is trying to do. It seems that there is enough liquidity in the system; also the Governor has said that we will keep options open to take measures as we go along."

But as of now, it's not necessary to assume that an impact on CRR is going to increase cost of deposits. We will have to watch what is the impact of the CRR hike and not just that, but more so the way liquidity moves in the system and how that impacts costs of deposits and only if it does affect cost of deposits, will you see any increase in lending rates.

On the impact on NIMs, she said, "As of now the impact on NIM is going to be minimal. In the month of March this year itself the interest rates were much more subdued than they what normally are in other years in the month of March. After that, if at all, there has been some amount of softening in the wholesale deposit rates, so there is currently no increase in cost of deposits and therefore there is no need to assume that there will be any impact on the lending rates immediately."

"If one reads the whole policy, then it's much less hawkish than what people were expecting it to be, so I don't read it as hawkish. What I read is that there is a recognition that to handle inflation there is also a supply side correction to be done and I think that is clear recognition to say that supply side measures do take a little time by which the correction can start and therefore the expectation levels have been set at these levels," she continues.

On interest rates she said, "In general what happens to interest rates will depend on the cost of deposits and not just by the movement of CRR."

Robert Prior-Wandesforde, Senior Asian Economist, HSBC , feels the repo rate is effectively dysfunctional at the moment and raising CRR will have an impact. "We are not out of the woods as far as either the CRR rate or even the repo rate is concerned. The CRR hike would have a much bigger impact on these commercial banks than raising the repo rate at the moment because banks are simply not using the repo rate window at the moment."