COLUMN - Expect banks to raise interest rates

By Tapan Bhaumik

REUTERS - The annual policy statement of the Reserve Bank of India is largely an attempt to boost confidence amidst widespread concern about rising inflation.

The key issue is that while inflation is a concern and price stability must be maintained, growth is equally important to sustain. In view of global economic conditions, nobody is expecting 10% GDP growth in 2008-09, but 8-8.5% is feasible.

However, it remains to be seen whether inflation can be brought down to around 5.5%. In this context, given normal monsoon and an increase in foodgrain production, it may be possible to lower foodgrain inflation to some extent, but the worry is with respect to oil prices , a purely exogeneous factor.

The rising prices of industrial raw materials also has to be kept in mind. These are all key challenges to bringing inflation down to 5.5%. Further the increase in CRR by 25 basis points is intended to curb M3 growth to 16.5-17% for the whole of 2008-09, calling into question whether this can lead to GDP growth of 8.5%.

This amounts to a severe attempt to curb money supply growth and is a matter of concern, because much will depend on how the distribution of credit takes pace. Normally what happed is that small and medium sectors of industry suffer the most, because they account for the bulk of manufacturing activities.

Another area of concern is about deposit mobilisation. RBI projects an increase of 17%. If commercial banks reponds to CRR increase by way of an increase lending rates, and if inflation continues to run high, deposit rates too will as otherwise they may lose customers.

In fact, today’s monetary policy is likely to put commercial banks into a tighter spot and could well have an adverse effect on profitability. In the stock market, bank stocks are likely to loose their sheen.

The critical nature of the situation facing the banking sector can be understood if we compare some figures. In 2007-08, money supply increased by 20.7%. In 2008-09, it is expected to increase by 16.5%.