India and Pakistan joined China on Tuesday in clamping down on bank lending and systemic liquidity in their fight against inflation.
MUMBAI: India and Pakistan joined China on Tuesday in clamping down on bank lending and systemic liquidity in their fight against inflation.
The Reserve Bank of India governor Yaga Venugopal Reddy used a blunt weapon to impound liquidity, the fourth time he has done so in 7 months, by hiking the cash reserve ratio (CRR) by 50 basis points to 7%.
The State Bank of Pakistan governor Shamshad Akhtar used a sharper tool: He lifted the bank rate by half a point to 10%, the highest in more than 5 years, as inflation soared to an average 7.7% this year in that country.
On Monday, People’s Bank of China governor Zhou Xiaochuan increased the CRR requirement for the 9th time in 13 months to 12% to keep the world’s No. 4 economy from overheating.
Analysts said RBI’s move to hike CRR on Tuesday may be the first of two this year.
Under the CRR norm, banks have to maintain a portion of their deposits (for Indian banks, it is 7% of deposits from August 4, from 6.50% now) with the central bank as a prudential and safety measure.
What goaded Reddy, Akhtar and Xiaochuan to act is the cash sloshing around in their respective banking systems. The danger of inflation getting out of hand is clear and present.
“While commercial loans have decelerated the acceleration in money supply and reserve money warrants an appropriate response,” Reddy said on Tuesday, during the quarterly review of the monetary policy.
Robert Prior-Wandesforde, an economist at HSBC Holdings Plc in Singapore, said the RBI is faced with a policy dilemma - the desire to control the exchange rate, while preventing short-term interest rates from remaining at absurdly low levels.
“We will pencil in a further 50 basis point increase in the cash reserve ratio before year-end,” he told Bloomberg.
Tuesday’s increase in CRR will drain Rs 16,000 crore from the banking system.
Interest rates in India’s call market have stayed near zero percent for three weeks as the RBI stepped up dollar purchases to prevent the local currency advancing from a nine-year high. In the process, it injected rupees faster than it could mop up. It slowed dollar purchases allowed the rupee to gain earlier to contain inflation.
Capital inflows are increasing as foreign investors buy more stocks in India, encouraged by unprecedented economic growth since 2003.
Overseas funds have bought a record $10.4 billion of stocks and bonds this year, helping the benchmark Sensitive index more than triple in the past three years.
“Surges in capital inflows and large changes in liquidity conditions are obscuring an accurate assessment of risks,” the central bank said in today’s statement.
“It is necessary tonote that while there is an abatement of inflation in the recent period, upward pressures persist.”
Additions to foreign-currency reserves, which are an indication of the Reserve Bank’s dollar purchases, rose $8.7 billion this month after a $5.1 billion increase in June.
Dollar purchases in March and April were $2.3 billion and $2.1 billion respectively, according to the central bank.
China yesterday ordered banks to set aside 12% of deposits to curb lending and investment after the economy grew at the fastest pace since 1994. “The difference between India and China is that India is using currency appreciation as well to curb inflation,” said Ramya Suryanarayanan, an economist at DBS Bank Ltd in Singapore.
The rupee has gained 9.5% this year, making it the best performer among the 10 most-traded Asian currencies.
That’s made imports cheaper. RBI has also increased its key repurchase rate six times in the past 18 months.
“Managing the rising quantum of capital flows without stoking inflation and containing the rupee’s appreciation, are likely to be the central bank’s foremost priority for the rest of this year,” said Gaurav Kapur, senior economist at ABN Amro Bank NV in Mumbai. “Its actions on this front will have repercussions for the economy.”
Higher interest rates are hurting companies such as carmaker Hero Honda Motors Ltd., while gains in the rupee are curbing earnings at the country’s largest software makers such as Infosys Technologies Ltd. and Wipro Ltd.
The government estimates growth may slow to around 8.5% in the year to March 31 from 9.4% in the previous year. “No company will be able to manage that kind of rupee appreciation in such short a time,” said Suresh Senapaty, chief financial officer at Wipro, India’s third-largest computer-services provider.
With inputs from Bloomberg
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