The RBI clearly said inflation has been contained. With that part of the current “trilemma” taken care of, is it time to attack the second?
MUMBAI: On Monday, the Reserve Bank of India clearly said inflation has been contained. With that part of the current “trilemma” taken care of, is it time to attack the second part, seasonal liquidity?
As he presents the first-quarter review of monetary policy today, inflation, at 4.4%, stands well below the RBI’s annual target of 5%, but the surfeit of liquidity has ground call rates to zero.
This excess liquidity is its primary cause for concern.
Abheek Barua, chief economist of HDFC Bank, says large and persistent excess liquidity creates conditions for an inflationary uptick.
“It could also boost credit growth sharply and breed exactly the kind of ‘overheating’ that the RBI has tried to tame in the past,” he wrote on Friday.
Therefore, Barua sees a case for a CRR hike of 50 basis points.
He estimates that the RBI bought dollars worth $5.5 billion (or injected Rs 22,000 crore rupee liquidity) in June alone to stop the rupee from appreciating.
The central government expenditure also went up by Rs 90,750 crore in April-May 2007, money which found its way back into the banking system. Not many, however, agree with Barua.
The refrain on the street is that apart from easier inflation, economic growth is also showing signs of deceleration, which gives the central bank the latitude to go easy on rates.
“The RBI may thus be keen to adopt a wait and see approach as there is always a risk that it may overtighten,” Shuchita Mehta, senior economist at Standard Chartered Bank, wrote on Monday.
Goldman Sachs economist Tushar Poddar says hiking CRR may not be effective as the RBI is already holding excess deposits from banks — at around 7.5% compared with the required 6.5%. “But the current accommodation of loose liquidity is dangerous and may spillover into inflation,” he warned in a July 27 report.
That surely is a case for more active sterlisation, Poddar said.
Which brings us to the third part of the ‘trilemma’ — portfolio inflows. In the short term, liquidity will also being generated because of yet another flurry of capital-raising plans by companies — just as the mega issues of ICICI Bank and DLF brought in inflows of $6 billion in June.
Prithvi Haldea of Prime Database says about Rs 15,000 crore of public issues are in the pipeline in the next two months, which would bring in additional foreign portfolio inflows.
Indranil Sen Gupta, Merrill Lynch economist, wrote that a higher cap than the Rs 3,000 crore under the reverse repo window can be used to mop-up seasonal liquidity.
Gupta expects the RBI to caution on risks such as rising oil prices, strong monetary expansion against a backdrop of sustained capital inflows and asset price inflation.
What all that means is even if the RBI does not hike rate this time around, they may not be far away if the trend continues.
A quarter point hike in repo and reverse repo and a 100 bps hike in CRR could be at hand in the second half, bets StanChart’s Mehta.
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