RBI hikes bank rate, CRR to prop up falling rupee

RBI hikes bank rate, CRR to prop up falling rupee
ENS ECONOMIC BUREAU

MUMBAI, JULY 21: The Reserve Bank of India (RBI) on Friday sprang a surprise by announcing a series of tough measures to stem the rupee fall, but raised the spectre of higher interest rates. The central raised the key bank rate -- the rate at which it refinances banks -- by one percentage point to eight per cent and tightened liquidity on Friday to support the rupee after it hit a record low of 45.07/08 against the dollar.

The central bank also raised banks' cash reserve ratio (the portion of deposits to be maintained by banks with the RBI) by 50 basis points to 8.5 per cent -- to be carried out in two stages, on July 29 and August 12. The measure will mop up Rs 3,800 crore from the banking system. The stern RBI measures are expected to push up interest rates across the board.

The rupee hit a new low on Friday, extending a two-week downtrend as foreign investors exiting the stock market converted their rupees into dollars. The fall in the rupee and the RBI measures also dampened the stock markets with the benchmark Bombay Stock Exchange Sensex falling by another 112 points.

The rupee hit its weakest intra-day level of 45.07/08 per dollar on Friday before recovering on intervention by the RBI through state-run banks. The rupee closed at an all-time low level of 45.01/03 amidst heavy dollar demand. With this, the rupee, convertible only on the current account, has slipped just under one per cent in the past two weeks. But it has depreciated by 3.5 per cent since the start of the year against a US dollar which has been flying high against other major international currencies.

While hiking bank rate and CRR, the RBI also reduced refinance limits, including the collateralised lending facility temporarily to 50 per cent of current eligibility. This will also be implemented in two equal tranches beginning July 29 and August 12. The RBI said it was hiking interest rates after reviewing recent developments in the international and domestic financial markets, including the foreign exchange market.

Bankers, industrialists and analysts were surprised by the sudden monetary tightening and hoped they were temporary. "This is an unexpected move. It is a cause for concern since the RBI had reduced interest rates a few months ago. This does not spell good news for the stock market," said an analyst with SG Asia Securities (India).

As the RBI measures came after the forex market closed on Friday, currency traders feel the rupee will recover sharply to 44.50 levels when the market opens on Monday. R Govindan, assistant general manager, treasury, Larsen & Toubro, said the rupee's weakness was more due to genuine dollar demand and the RBI could have responded by selling dollars.

"These money market measures may end up affecting the economy and industry. Of course, if they are short-term it is okay," he said. When the RBI lowered key interest rates at the start of the year, analysts said it would help push through an aggressive Rs 1,17,000 crore government borrowing programme and encourage faster economic growth.

The first quarter saw a strong growth in bank credit, and a near 100 basis points rise in long-term government bond yields. The RBI said it would not tighten liquidity to curb rising inflation and even during volatile swings in the rupee in May and June, it intervened through warnings against speculation and by selling dollars. Foreign exchange reserves are down $1.67 billion from all-time highs of $38.34 in mid-April.

Analysts feel it is the concern over dwindling capital inflows and a likely drop in the balance of payments surplus that has prompted the RBI to tighten. "The bank rate hike was expected. The economy is moving at a fast clip and the balance of payments pressure has resulted in a weaker currency... after spending around $2 billion of reserve moneythis was the only resort left to the central bank," said Aashish Pitale, head of research at J P Morgan.

Foreign investors have so far sold $448 million worth of stocks in June and July, and are believed to be the main drivers of the 10 per cent fall in the benchmark Sensex in the past two weeks.

IDBI chairman G P Gupta also termed the hike as an effective measure, saying it would arrest the steep fall in the currency. ``This step has been taken to check the manipulations in the currency market mainly on account of availability of cheap money,'' he said.