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The Reserve Bank of India (RBI) has announced the Annual Monetary Policy Review 2011-12 on 03 May 2011, raising the repo rate by sharp 50 bps to 7.25% from 6.75% with the immediate effect. The repo rate has been hiked by 250 bps since March 2010, when RBI initiated exit from accommodative stance. RBI had to take tough actions as the inflation for March 2011 at 9.0% was sharply above expectations, while inflation for FY2011 surged to 16 years high of 9.4%. The inflation has remained above 8% for 15 sequential months up to March 2011, while there remains upside risk from high oil and other commodity prices, incomplete pass through and its likely impact on fiscal deficit, elevated inflation expectations and price stickiness. RBI stated that the resurgence of inflation in the last quarter of FY2011 became a matter of concern. It further added that demand has been strong enough to allow significant pass-through of input price increases.
Pending a final decision on deregulation of Saving Bank Deposit Rate, RBI has decided to increase the savings bank deposit interest rate from the present 3.5% to 4.0% with immediate effect. Reserve Bank has put out a discussion paper debating the pros and cons of this proposal. It will review the policy of deregulating the savings bank deposit rate based on the feedbacks.
The rising interest regime is leading to hardening yields, which shall dampen the treasury income of banks. Also, the interest on savings deposits have been earlier shifted from the least amount held between 10th and last day of the month. But from 1st April 2011, as per RBI's directives, they have started paying interest on daily balance. Now RBI has hiked this rate from 3.5% to 4.0%.
As per Capitaline Databases, the aggregate savings deposits of 29 banks were about Rs 887267.27 crore in FY 2010, out of total deposits of Rs 3764736.04 crore. This means, that about 23.6% of the total deposits were savings account. On a simple calculation, this means about 14% increase in interest on savings deposits of the above sample from about Rs 30154 crore at 3.5% to Rs 35491 crore at 4.0%. But factoring in the shift to interest on daily balances, the actual impact for / from the current fiscal will be significantly higher from the previous year levels. The increase in cost of deposits is estimated at 10 basis points for banking system, due to increase in savings interest rates, without even factoring in the shift to calculating them on daily basis.
Also, banks are likely to increase interest on both lending and advances. This can affect the rate sensitive sectors like automobile, real estate, construction etc. High inflation and hardening interest rates can also affect the pace of growth in economy. As a result, there is a distinct possibility of increase in NPA levels of the banking sector.
RBI had no option but to take aggressive stand, considering the unacceptably higher inflation, and as it is becoming more generalized. Still, factoring in the domestic demand-supply balance, the global trend in commodity prices, and the likely demand scenario, RBI's baseline projection for WPI inflation for March 2012 is only 6%, but with an upward bias. It expects inflation to remain at an elevated level in the first half of the year, before gradually moderating to 6% by March 2011.
Already, the pace of growth in Index of Industrial production has tumbled down sharply from record 16.6% in April 2010 to mere 2.5% in December 2010 and 3.6% in February 2011. RBI acknowledged that High oil and other commodity prices and the impact of the anti-inflationary monetary stance will moderate growth. Assuming a normal monsoon, and crude oil prices averaging US$110 a barrel over the full year 2011-12, RBI has come out with benign baseline projection of 8% growth in GDP for 2011-12, for policy purposes. Perhaps, reining in inflation should has taken precedence even at some short-term costs by way of lower growth. So, expect more tightening of monetary policy through the fiscal, especially in the rest of the first half of the current fiscal.
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