Let there be hike...

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...says Reddy. What are banks upto?

The trio of – interest rates, exchange rates & inflation; assuming the prowess of the ‘impossible trinity’ in its own terms have been the source of major concern for the central banker. Amidst it, along with the continued capital inflows, the RBI had to choose amongst three possibilities; either allow rupee to appreciate, or add to reserves and sterilise the excess either through issue of bonds or raising the CRR (the slice of customers deposit that banks set aside as cash with RBI) or discourage inflows. Prudently enough, the central banker announced a 50 basis point (from 6.5% to 7%) hike in Cash Reserve Ratio (CRR).

As a result of excess foreign inflows, liquidity glut haven’t been ‘sterilised’, or absorbed by the central bank. This excess liquidity has the potential to drive up the inflation, which is at 4.41% and within the RBI’s comfort zone. “Managing liquidity has become the most challenging task,” exclaims RBI Governor Y.V. Reddy. These are good enough indications to guess that the RBI’s stance continues to remain the same – managing growth & price stability. The recent hike will drain Rs.160 billion out from the system.

RBI has been buying dollars in the market to keep a lid on the rupee appreciation. In the past two months, the gross purchase has been to the tune of $33.21 billion, which is reflected into the addition to the foreign reserves to the tune of $17.11 billion during the same period. Every dollar that the RBI buys, an equivalent amount of rupee gets infused into the system and this liquidity has to be controlled. As there have been not enough outflows to off set the forex inflows; by hiking CRR, RBI has asked banks to set aside an equivalent rupee that it got infused into the system by buying dollar.

Considering the situation, the central banker has done a good job as there was no other choice. But penalising banks by hiking CRR every time RBI sterilises inflows, defies logic. Hence, focus should be more on encouraging outflows.

B&E edit bureau: Gyanendra Kashyap

For Complete IIPM Article, Click on IIPM Article

Source : IIPM Editorial, 2007

An IIPM and Professor Arindam Chaudhuri (Renowned Management Guru and Economist) Initiative

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