Ever since the Reserve Bank of India (RBI) hiked policy rates in a mid-cycle move in second half of April 2010, expectations of increase in pace of normalisation of the monetary policy stance have picked up. In case the RBI continues to tighten things aggressively in the forthcoming policy review scheduled for April 20, there is strong possibility that market rates too will start inching upwards.
India’s central bank, in line with most of its global counterparts, cut down policy and reserve rates sharply in a series of moves following the onset of global financial crisis in September 2008. The monetary easing coupled with the fiscal stimulus had a strong positive impact and the relatively domestic demand driven Indian economy picked up strongly by second half of 2009.
However, as the growth picks up, inflation too has been surging, and even as the central bank is wary of hitting the nascent recovery and has been cautious in its steps aimed at normalising the policy stance, sharp increase in inflation has left the RBI little space. A key indicator of this was that despite openly rejecting the mid-cycle moves, except under unexpected circumstance, after the January review, the RBI was forced to resort to such a move by hiking policy rates by 25 bps in March.
If the RBI continues this policy normalising in April review, there will be greater pressure on banks to start tuning their rates in line with the RBI’s stance. A key factor that has been keeping the rates low is abundant idle liquidity in the system. However, couple of developments, including the 75 bps hike in cash reserve ratio (CRR) by the RBI in January policy review and a subsequent pick-up in credit growth to nearly 16% from 9% in December have ensured the liquidity is no more as abundant as it was a quarter ago.
Banks are already accepting this fact. Liquidity has gone down sharply, and if there is another hike in CRR, it will certainly drop to levels where banks will feel it necessary to hike deposit rates to attract more funds. This will automatically clear the way for increase in lending rates by banks.
Overall, it looks that if the April policy only sees a marginal (25 bps) policy rates hike, banks may still wait for some more time. However, if there is an aggressive tightening of policy rates (50 bps or more), or CRR is also hiked say by even 25 bps, then the rate hikes by banks will very much be imminent following the RBI review.