India:INTEREST RATE HIKE IMMINENT

Curtains for easy monetary policy No Change In Key Rates, But SLR Increased By 1% RESERVE Bank governor Duvvuri Subbarao on Tuesday ended the soft monetary policy — aimed at easing the credit crisis that kicked in last year — as he began the exit by withdrawing liquidity boosting measures, becoming the third central banker in the world to do so after Australia and Israel. An increase in lending rates is now imminent next quarter if consumer and asset prices remain high. Benchmark rates were, however, kept unchanged.      The governor withdrew a special facility making available funds from banks to mutual funds and finance companies, made it more expensive to lend to commercial real estate, forced banks to invest more in government bonds and asked lenders to set aside more funds for bad loans. The special facility was introduced last year to boost liquidity for firms in the financial sector after the credit markets froze.      RBI maintained the repurchase rate or repo rate — the rate at which the central bank provides funds to banks — at 4.75%; the reverse repo rate — the rate at which it takes funds from banks — at 3.25%, and the cash reserve ratio — the slice of deposits that banks have to mandatorily park with the central bank — at 5%.      But the central bank surprised the market in its choice of instruments to announce the exit of an easy money policy. The statutory liquidity ratio (SLR), which prescribes the percentage of deposits that banks are required to invest in government debt, has been raised from 24% to 25%, which Mr Subbarao said was a reversal of an exceptional measure. Last year, at the height of the global credit crisis, the central bank had lowered the SLR to ease credit flow to industry.      The apex bank also raised its forecast of inflation as measured by the wholesale price index to 6.5% by March 2010, from 5% earlier, as food prices continue to rise on short supply due to the worst-ever monsoon rains in more than a quarter of a century.      "We could see stronger action in the coming quarters," said StanChart India CEO Neeraj Swaroop. "The RBI will wait for stronger data before taking more aggressive measures," he said. JP Morgan India chief economist Jahangir Aziz also foresees a sharp rise in lending rates if the RBI were to increase interest rates later. The Indian Banks Association — the lobbying arm of commercial banks — said it expects interest rates to remain stable for a while.      Despite fiscal policy managers saying they want to ensure there is a solid rebound in growth before interest rates are hiked, the Centre and RBI governor have chosen a policy that leads rather than follows the market.  HOLDING TIGHT  A non-event?  Not really. Without hiking interest rates, the Guv has done enough to hint that rates will harden in a few months. Lending rules have been tightened and a few fire fighting measures taken during the October 2008 crisis have been withdrawn.  Whom will it hurt?  Builders and banks. Loans to builders, particularly those setting up office buildings, malls and multiplexes, will become more expensive. Banks will have to provide more, or set aside a bigger slice of their earnings for such a loan, even if the borrower does not default.  So, what happens to loans that have turned sticky?  Banks will have to step up their provisioning for bad loans. If a loan outstanding is Rs100 crore, a bank will have to provide a minimum 70% (or, Rs 70 cr). This will impact profits of many big banks. Bankers feel RBI should take a relook at this.  Has RBI made things difficult for the consumer?  No. Banks are not expected to hike interest rates on home, auto and personal loans, immediately. But they may in Jan. That's when RBI may hike CRR — the slice of customer deposits that banks set aside as cash with RBI — to reduce surplus money with banks.  Then why's Dalal Street nervous?  The market was set for a correction, & took the hawkish policy as a trigger. Realty stocks plunged & biggies like SBI and ICICI slipped. Besides higher provisioning, RBI said it will not relax the mark-tomarket accounting norm on govt. bond holdings of banks. So, banks will have to take mtm hits as interest rate rises.  Is RBI trying to discipline banks?  In a way. Besides new loan rules, it will also outline broad rules on the salaries banks pay to their CEOs and senior managers. While RBI today has the last word on CEO pay, there are no guidelines like the ones applicable for bonus payments. 'Pressure on inflation earlier than expected'  MR Subbarao is the third central banker after his Australian and Israeli counterparts to signal the exit of an accommodative monetary policy, which was eased drastically in concert with other central banks of the world a little over a year ago in response to the global financial crisis. Union finance minister Pranab Mukherjee said that the status quo on policy was in line with the government's discussions with the RBI. The assessment of the RBI on the whole is in conformity with the government's own thinking on both fiscal as well as monetary policy he told reporters in New Delhi on Tuesday.      Last year, when monetary authorities world-wide eased policy, many had harboured concerns that the resultant liquidity would push up asset prices and stoke inflationary pressures. According to Mr Subbarao, the pressures on inflation were being felt earlier than expected. The governor has warned that pressures could increase stating that "the lag with which monetary policy operates suggests that there is a case for tightening sooner rather than later".      While the RBI has broken ranks with other central banks in timing its exit, it has moved in tandem with global regulators in acting on other issues. For instance, the RBI has decided to draw guidelines on how much banks can pay their CEOs. It has also introduced curbs on securitising loans and has announced a stress test for all banks next year.      While the governor was alarmed with the secular rise in prices of all asset classes — real estate, equities, gold and commodities — resurgent foreign portfolio, or FII, flows of $14 billion in the first seven months appears to have reassured him that recovery will not be hit. The fact that year-on-year bank lending to real estate has grown 43% as on end-August had already sparked speculation that the RBI may act on these loans. As Mr Subbarao said, although the amount of credit to real estate is not very high, it has been the fastest growing.      By choosing to increase the extent of standard provisions that banks need to make on real estate loans, the RBI has discouraged fresh loans, yet at the same time has ensured that the capital adequacy ratio is not hit because of existing loans.      The RBI has said that it expects activity in the service sector to grow with a lag and it also points out that inflation has returned to positive territory earlier than expected. The governor pointed out that the upside risks have already materialised. Attention has shifted from managing the crisis to managing the recovery.      The SLR is a throwback to the pre-reform age when banks were forced to finance large government deficits. Committee after committee has called for a reduction in SLR and find other investors for government bonds. The RBI too has been eschewing the use of blunt instruments for several years. Mr Subbarao said that "for the very long term, as in Keynesian stance, we expect SLR to come down. It is a reversal of an exceptional measure". Finance secretary Ashok Chawla said that the hike in SLR does not affect ground reality considering that banks hold, on an average, well in excess of the mandated level.     By forcing banks to invest more in government securities, the RBI seems to be willy nilly sending out a signal that the government's fiscal deficit would continue for some time. The government has projected the fiscal deficit for FY10 at 6.8% of the gross domestic product or GDP. The SLR hike would ensure easy funding of the government borrowing for not just this year but the next fiscal as well.      The central governor has systematically demolished all arguments against delaying the exit stating that the indirect impact on private consumption and investment will persist for some more time. Mr Subbarao said that there was no informal commitment on exit at the G-20 meeting. According to him there was an agreement that measures would continue as long as necessary and the exit should be co-ordinated. "Co-ordination does not mean synchronisation," he said.