RBI is in a dilemma. To ensure inflation does not rise further, RBI will decide to hike key rates. RBI has already increased increase CRR 13 times since December 2006 to reach 8.7% as on July 19,2008. Since April 1, RBI has increased CRR by 1.25 percentage point leading to an evacuation of over Rs.47,500 crore from the system. Any further increase in CRR will affect the credit availability to the industry. Banks are borrowing somewhere between Rs.40,000 crore and Rs. 50,000 crore from RBI every day at a rate of 8.5%. Now, if the central bank increase the cash reserve ration (CRR), then the proportion of savings that a bank needs to keep with RBI (by 0.25%), it will suck out over Rs.8,000 crore from the system. This will further increase the banks dependence on RBI for short term funds to meet daily liabilities.
Lending rates have gone up in the last couple of months, borrowings for productive sectors have almost dried up. The growth in retail credit is even worse. The retail credit growth of the bank in 2008- 2009 is expected to be in a range of 5% only. Also, if RBI increases the repo rate, at which it lends short term funds to bank against governments securities, the interest rate will further increase. Bank will have no option but to pass on the rate to borrowers. This will further slow down the growth.
BRI is likely to increase both CRR and repo rate. RBI has earlier indicated that it will take harsh measures to contain inflation even if it affects the economic growth with inflation around 12% RBI has no choice but to take steps to kill any further pricing pressure. In the current financial year so far, money supply stands at 20.5% as against RBI’S projection of 17%. Hence, before inflation shoots up further, as it happened in May and June, RBI would like to play safe and will increase CRR to tighten the money supply even further.
