Hawkish RBI hikes CRR by 75 bps, says stance is pro-growth

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The Reserve Bank of India has hiked its cash reserve ratio by 75 bps to 5.75% as against 5% at its credit policy meet today. (100 basis points=1%) A CNBC-TV18 poll had forecasted a 50 bps CRR hike.

The move will be implemented in two stages. The first 50 bps hike will come into effect on February 13 while the next 25 bps hike will be effective February 27. The move will result in a mop-up of Rs 36,000 crore by February end.

The central bank has left unchanged the reverse repo, repo, and bank rate at 3.25%, 4.75%, and 6% respectively. 

Rationale for the hike:
D Subbarao, Governor, RBI, says the confidence in India's recovery justifies reversing the expansionary policy. "The policy at current levels was more consistent with the crisis situation."

However, he acknowledged that the recovery was yet to take hold fully. "Though the recovery is reassuring, it is still unbalanced and yet to be sufficiently broadbased. Our interest rate stance will balance price stability and support growth." Industrial production in November 2009 grew at 11.7%, the fastest in the last two years.

Expected Outcomes
- Reduction in excess liquidity will help anchor inflationary expectations.
- The recovery process will be supported without compromising price stability.
- The calibrated exit will align policy instruments with the current and evolving state of the economy.

Road ahead:
The governor says it necessary to carry forward the process of (stimulus) exit further. But was quick to add that strong anti-inflationary steps may undermine the recovery process. The Monetary Policy for 2010-11 will be announced on April 20.

GDP forecast:
The Reserve Bank has revised its FY11 growth forecast of 7.5% from 6% earlier. The forecast assumes 0% agricultural growth and continued recovery in industry services. However, it says a possible spike in oil price is a risk to India's growth.

Inflation:
The March-end inflation forecast has been upped to 8.5% from 6.5%. The governor has promised to respond to inflation swiftly via policy adjustments. It expect inflation to moderate from July. "The monetary policy will contain inflationary perception to 4-4.5%. We retain our medium-term objective of 3% inflation," Subbarao stated.

Growth forecasts scaled lower:
Credit growth forecast has been lowered to 16% from 18%. Deposit growth expectation has also been downsized to 16% from 18%. M3 growth forecast has been revised to 16.5% from 17%

On liquidity:
RBI has hinted at more market stabilisation schemes. It expects large capital flows due to India's growth and on account of high global liquidity. "Capital flows could mean exchange rate appreciation and large domestic liquidity. The sharp rise in flows may complicate exchange rate management."

RBI cautions on fiscal deficit:
The policy says the biggest risk to economic management stems from fiscal deficit. "There is need for coordination in fiscal, monetary policy. A reversal of monetary stance is effective only if there is a fiscal rollback (of stimulus)."

Subbarao says large liquidity helped fiscal expansion in FY09, FY10. He added that liquidity is not available to accommodate fiscal expansion in FY11. "It is imperative for the government to return to fiscal consolidation. The government must indicate its roadmap for fiscal consolidation and spell out the broad contours of tax policies, and expenditure cuts."

These statements will further add to Finance Minister Pranab Mukherjee woes, who will be presenting the general Budget on February 26. He has the tough task of balancing growth as well as fiscal deficit concerns.

Rate hikes in sync with other central bank moves:
The Reserve Bank has joined other central banks in Asia in taking steps to start unwinding ultra-loose monetary policy. On Thursday, the Philippines raised a short-term lending rate, and this month China started to tighten policy by raising banks' reserve requirements and accepting higher yields at bill auctions.

Australia was the first Group of 20 countries to begin raising rates as the global economy recovers from its worst downturn since the Great Depression. The Reserve Bank of Australia has raised its key cash rate by 75 basis points since October.