In hiking the banking sector?s cash reserve ratio (CRR) by 50 basis points, the Reserve Bank of India (RBI) has addressed the effects of capital flows from abroad rather than the flows themselves in its mid-term review of annual policy. It has sought to swab the economy of liquidity by operating through the banking system. With inflation perceptions softening now and the spectre of elections having receded, it was clear that a frontline attack on inflation?through interest rate signals?would have been unwarranted. Not only has inflation slipped in the priority order, its relevance to the central bank?s agenda now has to be seen in the context of the capital inflows predicament. With so much money sloshing around, any sudden supply squeeze still runs the risk of sending prices up. Mopping up liquidity injected by the purchase of dollars, itself done to restrain the rupee?s rise, has been proving harder by the day. The government has already issued Rs 2,00,000 crore of market stabilisation scheme bonds this fiscal, and with the interest cost of this operation to sterilise the intervention having crossed Rs 15,000 crore, raising the ceiling for such bonds within 2007-08 looks inevitable. In the interim, the RBI has little option but to deploy the CRR towards roughly the same objective. The question is for how long the rupee can be restrained in this manner. This also depends on the RBI?s assessment of the extent to which the currency can strengthen. Given the looming infrastructure constraints, a weaker US market and therefore lower export buoyancy, the rise may not continue for very long. But then, how much the stock market draws in remains unpredictable.
The other question is the immediate impact of the CRR hike. It is unlikely to translate into a rise in retail interest rates. Commercial banks are uncomfortable with high lending rates, and have been offering cheaper credit on their own volition, and so their lending stance may remain unaltered. But if their net interest margins come under pressure, their credit books, which have whittled down consumer lending already, could become even more bleached. The RBI has also tried to incentivise a reduction in the exposure of some banks to the real estate sector and capital market. So, if bank stocks have taken a hit, so have consumer goods and real estate company stocks.
