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Tags: india | central | bank | reserve

India's Central Bank Raises Reserve Requirements

Friday, 29 January 2010 07:51 AM EST

India's central bank hiked cash reserve requirements for lenders but left key interest rates unchanged Friday as it tries to contain inflation without undermining an economic recovery.

The three quarters of a percentage point increase in the reserve requirement for banks to 5.75 percent was more than expected.

It will be carried out in two steps.

The Reserve Bank of India also raised its projection for economic growth for the fiscal year ending March from 6 percent to 7.5 percent. It says inflation will likely hit 8.5 percent by March.

The bank said the hike in reserve requirements would drain 360 billion rupees ($7.8 billion) of liquidity from the financial system.

This is the first meaningful monetary policy reversal from the Reserve Bank, which has infused India's trillion dollar economy with more than $125 billion in actual or potential liquidity since the global financial crisis hit in September 2008.

The new reserve requirements will be implemented with a half-point hike effective Feb. 13 and a quarter-point hike on Feb. 27.

Economists had expected a half-point increase in the cash reserve requirement and predict the bank will start raising policy rates by April, with cumulative increases of up to 1.25 percentage points over the next fiscal year.

As economic recovery takes root, central banks have begun to reverse monetary stimulus measures.

In October, Australia became the first major economy to raise interest rates since the outbreak of the financial crisis, hiking its key rate by a quarter point from a 50-year low.

Three weeks later, Norway followed suit.

This month, China ordered banks to set aside more reserves to staunch lavish lending and cool what could be a real estate bubble.

The Philippines inched toward a monetary policy reversal Thursday, resetting a short term interbank loan rate to pre-crisis levels, but left key lending rates unchanged.

India has emerged from the global bust faster than many expected, but much of its economic growth — which bounced back to 7.9 percent in the July-September quarter — has been fueled by extra government spending.

Goldman Sachs calculates that government spending contributed 40 percent to 50 percent of India's total GDP growth in the year to September, and economists worry that hiking rates before private investment gains traction could undermine the recovery.

At the same time the Reserve Bank is struggling to cope with rampant food price inflation, which it has little power to contain.

In December, the headline wholesale price index jumped 7.3 percent.

Most of that rise was driven by food prices, which surged nearly 22 percent, as India's weakest monsoon in four decades and persistent distribution bottlenecks created supply side constraints, which monetary policy can't do much to fix.

But as consumer demand and industrial activity pick back up, pushing up wage and input costs, non-food inflation has been rising as well.

Prices of manufactured products rose 5.2 percent in December, up from a 0.5 percent rise in September, suggesting that inflationary pressures have already begun to spread beyond drought-affected farm products.

"The RBI is exiting from its accommodative monetary stance and moving from managing crisis to managing recovery," said Abheek Barua, chief economist at HDFC bank.

"The implication is that going forward rates will start moving up."

Beginning in September, the Reserve Bank cut the cash reserve ratio — the amount of cash banks must keep on hand —by 4 percentage points.

It also cut the benchmark repo rate — at which the central bank makes short-term loans to commercial banks — from 9 percent to 4.75 percent, and slashed the reverse repurchase rate — the rate at which it borrows from commercial banks — from 6 percent to 3.25 percent.

Those policy rates were left unchanged Friday.

The bank began leaning toward a policy reversal at its last meeting, in October, by undoing some special measures to boost liquidity it introduced in late 2008.

The Reserve Bank also warned Friday that unwinding monetary stimulus will only be effective if the government also reigns in borrowing.

Barua said he expects the central government's deficit to fall from 6.8 percent of gross domestic product this fiscal year to 5.5 percent next, which is still above targets.

"The RBI might say a lot publicly but it will have to live with the hard fact of high deficits and high borrowing for at least two or three years."

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India's central bank hiked cash reserve requirements for lenders but left key interest rates unchanged Friday as it tries to contain inflation without undermining an economic recovery. The three quarters of a percentage point increase in the reserve requirement for banks...
Friday, 29 January 2010 07:51 AM
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