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BW Businessworld

More On The Way From Worried RBI

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After a pause of five months, the RBI said on Thursday it was lifting its cash reserve ratio (CRR), the proportion of deposits banks must keep with the central bank, by 50 basis points to a seven-year high of 8.0 percent.
The move will drain Rs 185 billion ($4.6 billion) from the banking system. The aim is to lower the level of inflation-fuelling ready cash and keep money market rates firm -- a step the central bank preferred to forcing commercial rates higher with an official lending rate rise.
But analysts say in reality there is little the central bank can do to dampen the supply-side pressures that have pushed annual inflation above 7 per cent, as these largely stem from a rise in international prices of oil, food and metals.
Still, last week's surprise move so close to a scheduled policy review on 29 April is a sign, some say, that the central bank wants to stagger its steps and another cash tightening, currency appreciation or higher policy rates is on the way.
HSBC economist Robert Prior-Wandesforde expects wholesale price inflation to accelerate to 8 per cent, and possibly beyond, and sees the central bank debating whether to raise its 7.75 per cent short-term lending rate, the repo rate, next week.
"Given the level of inflationary concern, this seems more likely than not, and we have pencilled in a 25 basis point increase," he said.
Fighting rising prices has become a top priority for the government as it heads towards a national election due before the end of May 2009, and it has implemented a string of duty cuts and export bans to keep prices down and supplies adequate.
The central bank refrained from action while it assessed the sudden price spurt after the inflation rate doubled from just over 3 per cent in November, and said last Thursday's reserve rise aimed to contain inflationary expectations.
Market Undecided
In the bond market on Monday, the 10-year bond yield jumped to 8.21 per cent, its highest in nearly 10 months, in the first trading day after the decision, but dealers were not clear what the monetary authority would do next.

"I am not sure RBI will hike the repo rate in the policy. But they may take more measures to tighten liquidity," said Mahendra Jajoo, chief investment officer for ABN AMRO Mutual Fund.
Economists say the reason the central bank would want to avoid an outright rate rise is because the economy is already cooling after aggressive tightening in 2006 and 2007. Higher rates now would hit the investment needed to ease supply shortages responsible for price pressures in the first place.
Many banks forecast growth will slow below 8 percent this fiscal year after 8.7 per cent in the year that ended in March and some, such as Morgan Stanley, say for that reason another reserve ratio increase is more likely than a higher lending rate.
UBS expects the central bank to allow a little more rupee appreciation, after a gain of more than 12 percent against the dollar last year, as its intervention to keep the currency down has pumped cash into the domestic market, adding to inflationary pressures.
Interventions have kept the rupee between 40.85 and 39.15 per dollar for the past seven months and UBS saw the currency gaining to 39.00 over a three-month horizon.
Raising the reserve requirement again would also be cheaper for the government than issuing special intervention bonds to drain excess cash, as the government pays interest on the bonds, UBS said.
Some economists, though, expect the central bank to take more time before it acts again.
"There could be more CRR increases going forward and it's likely to be undertaken as and when warranted and not necessarily on a policy announcement date," said Indranil Pan, economist at Kotak Mahindra Bank.
But HSBC's Prior-Wandesforde said even another prompt central bank tightening would not bring down inflation markedly any time soon.
"Even if it was a demand-driven inflation, which it isn't in my view, it would take an awful long time to impact. I think it would take a minimum of two years for rate changes to have a meaningful impact."