Nearly three years after the Reserve Bank of India began its move towards a soft interest rate regime, the trend is seeing a slow but sure reversal.
The RBI hiked the CRR (Cash Reserve Ratio) in order to limit liquidity (supply of money) in the market during the weekend. The CRR has been raised to 5% (from the current 4.5%), in two installments of 25 basis points each.
The first 25 basis points hike will be done on September 18 and the second hike is scheduled for October 2, 2004. This move is essentially to counter the inflationary pressure being witnessed in the economy currently.
Inflation, as measured by the wholesale price index (WPI) is well above the 8% mark. This has worried the RBI and has consequently led to this revision in CRR.
While the central bank has taken this measure, it has also indicated that it is committed to maintaining the current monetary policy stance to meet credit growth and to support investment and export demand, given the current liquidity conditions.
In this regard, it is important to note that despite raising the CRR, the RBI has indicated that it is still committed to bring down CRR to its statutory minimum of 3 per cent.
This indicates that the current RBI measure could only be short-term in nature and it could mean a negligent impact on the interest rates prevalent in the economy. One also has to take into account the fact that the current inflationary scenario is mainly in result of a spike in crude prices in the recent past.
Since inflation has a lag effect, we are looking at a spike in inflation rate currently, despite a fall in crude prices from their highs. To that extent, we could say that inflation could ease in the short-term as crude prices have shown a stabilizing trend.
All these factors put together indicate that the measure by the RBI could be short-term in nature. Another aspect of the hike in CRR is worth observing is the timing of the announcement. The hike in CRR has been announced just before the busy season monetary policy announcement.
This indicates the proactiveness on the part of RBI, indicating that we could see further unexpected monetary policy announcements if need be.
Though the move is unlikely to set interest rates blazing in the short term, but it does indicate that inflation has caught the apex bank's attention. If inflation does not show signs of receding, the RBI's 'soft' stance may see a hard landing.
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