The Reserve Bank of India (RBI) on Friday tightened the monetary policy by raising the Cash Reserve Ratio — the portion of deposits that commercial banks are required to keep with the central bank —- by 75 basis points to tame rising inflation.

This increase in CRR from 5 to 5.75 per cent would absorb Rs.36,000 crore of excess liquidity from the system.

However, the RBI retained indicative interest rates, including repo rate and reverse repo rate — the rates between the RBI and the commercial banks — at their current levels. As a result, commercial banks are unlikely to raise lending rates from the current levels.

More challenging

“This time around policy decision was much more complex and challenging,” said RBI Governor D. Subbarao, while addressing a press conference here on the Third Quarter Review of Monetary Policy 2009-10, on Friday. He said there was sufficient liquidity in the economy even after sucking out Rs.36,000 crore from the banking system. “We hiked the CRR without hurting growth,” Dr. Subbarao added.

The RBI expects three major outcomes from the policy action: Reduction in excess liquidity will help anchor inflationary expectations; the economic recovery process will be supported without compromising price stability; and the calibrated exit from expansionary monetary policy will align policy instruments with the current and evolving state of the economy. The central bank upped its economic growth projection for the end of current fiscal to 7.5 per cent from its earlier estimate of 6 per cent. It also estimated that inflation would touch 8.5 per cent by March-end from its earlier projection of 6.5 per cent in October.

However, on the assumption of a normal monsoon and global oil prices remaining around the current level, it is expected that inflation will moderate from July 2010, said Dr. Subbarao.

This moderation in inflation will depend on several factors, including the measures taken and to be taken by the Reserve Bank as a part of the normalisation process.

Banks felt that credit growth prospects remain favourable going forward. They emphasised the need to expand their capital to sustain their lending operations in future. Banks indicated that they have reduced their lending rates responding to earlier monetary easing by the RBI. Consequently, “their net interest margins have come under pressure. Non-performing assets (NPAs) are expected to increase, particularly from the restructured assets.”

Bankers also informed that if the government borrowings next year are large, they could put pressure on resources and interest rates as credit is expected to pick up significantly.

Banks were concerned about their growing exposure to the infrastructure sector and suggested that policy intervention is required from the government and the RBI to address the issue of the asset-liability mismatch and exposure in their balance sheets.

(Click here for the Third Quarter Review of Monetary Policy 2009-10; see related media for PDF 169kb)

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