Twenty-five basis point hike expected in RBI’s monetary policy tomorrow
Munira Dongre 01 November 2010

Analysts and economists at brokerages expect interest rates to rise by a minimum 25 basis points at the RBI’s half-yearly review tomorrow

The Reserve Bank of India (RBI) has increased the repo and reverse repo rates five times since March this year - repo rate by 1.5% and the reverse repo rate by 1.75%. The repo is now at 6% and the reverse repo is at 5%.

The general expectation from the RBI tomorrow is of an 'at least' 25 basis point hike in the reverse repo rate (the rate which the RBI gives banks to park their funds with it) to 5.25%. The expectation about repo rate (the rate at which banks borrow money from the RBI) is divided with almost half believing that it will probably be kept unchanged at 6% because of already tight liquidity, and the other half expecting it to rise to 6.25% to help curtail inflation.

The market's expectation is reflected in the rising yields of the benchmark 10-year G-Secs which has risen from below 8% levels to about 8.15% in a month's time.
The consensus also believes that the RBI will not touch the Cash Reserve Ratio (portion of deposits that the banks keep with RBI in cash).

Inflation is still expected to be a big worry for the RBI but things are perceived to be getting a little better with the adequate monsoon in most parts of India helping cool food prices. The wholesale price index rose 8.62% in September vs. 8.5% in August and food inflation eased mid-October to 13.75% vs. 15.53% the previous week. Finance minister Pranab Mukherjee made statements to the press that while inflation was a concern he was positive about the fact that after 11 months of double-digit inflation, the wholesale price index as well as all three consumer indices fell to single digits.

As usual, the RBI is expected to walk a tightrope balancing credit growth, inflation, liquidity, and trying to be in line with global policies as well. Globally, the consensus is leaning towards one more round of easing from Europe and the USA. The US federal open market committee will meet a day after the RBI monetary policy announcement and is expected to announce a second round of quantitative easing to the extent of about $500 billion.

As on 8th October, banks have disbursed Rs2.24 trillion of credit (a 7% y-o-y growth) so far in FY11. Credit to the commercial sector was Rs 2.28 trillion, up 6.5% y-o-y. Food credit was up 16.5% y-o-y to Rs497.5 billion and non-food credit was up 20% to Rs2.23 trillion. Deposit growth was lagging behind at 6.6% at Rs2.95 trillion.

For most of the year, liquidity has been in deficit with banks accessing the repo window to borrow Rs1.2 trillion from the RBI. Some expect the RBI to expand its Market Stabilisation Scheme from the current level of Rs500 billion, sometime in the second half of FY11.

A report from brokerage Kotak to its institutional clients today says, "RBI decided to open a special second LAF window on October 29 and on November 1 along with a special 2-day repo auction on October 30. Added to these, RBI also decided to do an effective 1% cut in SLR for October 30-31. In our view, liquidity will remain tight even in November if the government does not start to spend soon. The repo rate will continue to be the operative rate going forward."

CRISIL and FICCI expect a 0.25% hike in the repo and reverse repo. Citi says in a latest report, "We maintain our view of the RBI hiking once or possibly twice by fiscal year end. This would take the repo/reverse rate to 6.50/5.50 from 6.00/5.00 currently. Growth outperformance and capital inflows searching for high rates of return will lead to INR strength and we expect the INR to trade at Rs43.5/US$ and Rs42/US$ by Mar 11 and Mar 12 respectively."

(This report is based on secondary research and is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author's own and may not necessarily represent those of Moneylife).

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