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Possible Moves By RBI On April 29
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The Reserve Bank of India (RBI) is expected to hold its fire at a policy review on April 29, according to a slim majority in Reuters poll, but a significant minority see the possibility it will take some action to fight inflation.
Wholesale price inflation hit 7.41 percent in late March, its highest in more than three years, well above the central bank's preferred ceiling of 5 percent. Data on Friday is expected to show annual inflation at 7.38 percent in mid-April.
Following are some of the instruments available to the RBI and possible scenarios.
REPO RATE: This is the short-term rate at which the central bank lends cash to banks. The rate has been steady at 7.75 percent since March 2007.
REVERSE REPO RATE: This is the short-term rate at which the central bank absorbs cash from the market. It has remained steady since July 2006 when it was raised to 6.00 percent.
CASH RESERVE RATIO (CRR): The CRR is the percentage of banks' deposits which they must keep with the central bank. On April 17, the RBI said it would raise the CRR by 50 basis points to 8 percent, in two steps of 25 basis points on April 26 and May 10.
BANK RATE: Banks use this to price long-term loans to firms and individuals. It has been steady at 6.00 percent since 2003.
1. KEEP ALL RATES UNCHANGED:
This is the base case according to the Reuters poll.
ADVANTAGES: Banks will keep their lending rates unchanged and this will not impact borrowing costs for companies at a time when analysts say investment is the main pillar for economic growth.
DISADVANTAGES: Doing nothing could entrench inflationary expectations ahead of fiscal stimulus expected from a hike in public sector salaries and additional tax exemptions. It will also leave the central bank more to do if inflation accelerates.
2. RAISE REPO RATE; KEEP ALL OTHERS UNCHANGED:
A 25 basis point increase in the repo rate looks the second most likely scenario, according to the poll, as the 7.75 percent repo rate is only just above current inflation rate.
ADVANTAGES: Strong signal to banks to raise lending rates to stamp on inflationary pressures stemming from demand. A signal relative to inflation expectations that monetary policy will remain vigilant.
DISADVANTAGES: Growth is already decelerating, consumer goods output has slowed sharply in the past year and a rate rise could dent investment, which is offsetting the slowdown in consumption.
A rate rise would also take a long time to filter into the broader economy, especially when the government is looking for a speedy slowdown in inflation heading into elections.
3. RAISE REPO RATE, REVERSE REPO RATE; OTHERS UNCHANGED:
Few expect a rise in both the repo and reverse repo rates.
ADVANTAGES: Overnight cash rates usually hover between these two rates and so raising the corridor may force banks to increase lending and borrowing rates. This could curb borrowing and encourage more savings, which could help dampen price pressures.
DISADVANTAGES: Growth is slowing already and the move could reduce demand further.
4. RAISE REVERSE REPO RATE; OTHERS UNCHANGED:
Only one analyst in the Reuters poll expects just the reverse repo rate to be raised.
ADVANTAGES: It would narrow the differential between the official short-term lending and borrowing rates, currently 175 basis points and its widest in four years. This would reduce volatility in interbank cash rates and keep them in a tighter and slightly higher range. It would not be an outright tightening, which might force bank rates up and harm investment and growth.
DISADVANTAGES: It would send a confusing signal to banks as they could then earn more on the surplus cash they park with the central bank and not pay more when they borrow from it.
5. RAISE CRR; OTHER RATES UNCHANGED:
Very few expect the central bank to raise the CRR this time after April 17's 50 basis point hike. The second stage in the increase will take effect after the policy review anyway.
ADVANTAGE: Another increase would drain any surplus inflation-fuelling cash from the banking system and give the central bank more headroom to cap unwanted rupee gains via intervention. M3 money supply growth is consistently topping 20 percent, above the central bank's 17.0-17.5 percent comfort zone.
DISADVANTAGES: The heavily front-loaded government borrowing programme could suffer as banks are forced to leave more cash lying idle and their capacity to buy bonds is blunted. Tighter cash conditions could also stifle economic growth. Analysts say this is a blunt instrument which penalises the banking system.
6. ALLOW MORE RUPEE APPRECIATION; LEAVE ALL RATES STEADY:
This is unlikely to be stated explicitly in the review. However the central bank let the rupee rise sharply a year ago to relieve pressure from capital inflows and curb inflation.
ADVANTAGE: 70 percent of India's oil is imported so this would help reduce or at least stabilise landed costs. Analysts say some inflation is being driven by rising commodity prices globally and a stronger rupee would cool these at the margin.
DISADVANTAGE: Politically difficult after sharp appreciation last year prompted government to come up with relief measures for exporters and dented its export target. Economists also debate the effectiveness of such a move in an economy competing with China but also not as open as some more developed economies, and say rupee appreciation would attract more capital, which would push it higher again.
7. MARKET STABILISATION SCHEME (MSS) CEILING INCREASE:
A way to manage liquidity that can be used in conjunction with another policy lever. Market participants say raising the ceiling for MSS bond issues to soak up liquidity generated by central bank intervention to keep the rupee down is probably not needed at the moment. The current ceiling is 2.5 trillion rupees ($62.5 billion) and the central bank has issued 1.71 trillion rupees worth of bonds.
ADVANTAGES: Adds central bank firepower to drain excess liquidity if it continues to try to keep the rupee in check.
DISADVANTAGES: Government pays interest on the bonds, so there is a fiscal cost.
Annual wholesale price inflation has been at 5 percent or higher since mid-February. It hit a peak of 7.41 percent in late March, its highest since November 2004.
GDP expanded 9.6 percent in 2006/07, its highest in 18 years. The government estimates growth at 8.7 percent in 2007/08 and analysts see it falling to about 8 percent in 2008/09.
The monsoon is forecast to be near normal this year. Only 40 percent of farm land is irrigated so rains influence rural output and farm incomes.
The Government plans to issue 960 billion rupees of bonds in April-Sept, and a gross total of 1.45 trillion rupees in 2008/09.