India's central bank is expected to tighten monetary policy at its Jan. 29 review, most likely by increasing banks' reserve requirements, as it unwinds policies aimed at shoring up the economy against the global crisis.
At the previous quarterly review in October, the Reserve Bank of India ended some liquidity support introduced during the crisis and no longer needed by the market. It said that marked the first phase of exit from easy policy.
Since then, a run of strong economic activity and rising prices have seen the market factor in tighter policy from January to contain inflationary pressures, although doubts on the strength of the recovery mean interest rates may not rise just yet.
Here are some of the possible policy decisions on Jan. 29.
Raising cash reserve ratio
Seen as the most likely outcome, with most discussion on whether it will be a 25 basis point or 50 basis point increase in the cash reserve ratio, the proportion of deposits banks keep with the central bank.
The amount of money being parked at the central bank's daily reverse-repo window suggests that mopping up some fund from the financial system by raising the CRR would not unduly hit banks or economic activity, but could help head off inflationary pressures down the track.
Every 50 basis points hike in the CRR is likely to drain about 200 billion rupees (USD4.3 billion) from the banking system.
Given banks have been depositing around 800 billion to 1 trillion rupees with the central bank each day, there would still be ample credit available.
The RBI will look for signs of demand-side pressures, such as credit growth, asset prices, and manufacturing prices, in deciding on whether and by how much to raise the CRR.
A CRR change has an immediate impact on funds in the market, and is more effective than a rate rise in liquidity management.
Raising cash reserve ratio and reverse repo rate hike
Strong economic domestic activity and rapidly rising food prices have some expecting the central bank will raise the CRR and the reverse-repo rate, its short-term borrowing rate.
Annual food price inflation reached 20 percent in December. While that reflects supply problems after a poor monsoon, authorities are worried about a spillover into broader inflation and manufacturing prices have started to pick up recently.
A rate rise -- 25 basis points is expected to be the starting move -- would signal the central bank's concerns on inflation.
Raising reverse repo rate, repo rates, leaving CRR steady
An outside chance. Raising both its key policy rates but leaving the CRR steady, the RBI could signal it was looking to contain inflation pressures and keep the economy on a sustainable path, without disrupting a pick-up in credit growth. The repo rate is the rate at which the RBI lends funds to banks.
Such a move would send also a message to banks to ensure loans made could be serviced by customers, as the central bank has expressed concern about low introductory rates on loans.
Credit growth remains a key factor for the central bank to decide on the extent and method of tightening monetary policy.
If RBI chooses to raise both the reverse repo and repo rate instead of just the reverse repo rate, it may be seen as a strong signal because it would raise banks' cost of funds.
Raising CRR, reverse repo and repo rate
Seen as unlikely, as it would send a very strong signal on interest rates and liquidity at a time when the durability of the recovery is still being determined.
Raising CRR and both policy interest rates could be seen as the central bank wanting an immediate increase in banks' lending rates to curtail inflation and stop the economy from overheating.
However, given the RBI's concern on credit growth, it is highly unlikely that it would want to send such a strong signal.
(USD1 = 46 Indian rupees)
Source: ReutersCourtesy moneycontrol.com
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