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RBI announces annual review

RBI to increase cash reserve ratio from April 28 to suck out excess liquidity, reports Gaurav Choudhury.

business Updated: Apr 23, 2007 20:57 IST

A day ahead of the announcement of the credit policy, the Reserve Bank of India (RBI) in its annual review maintains that prices of primary goods remain high.

"Prices of primary food articles and manufactured products exerted upward pressures on headline inflation in 2006-07," says the document Macroeconomic and Monetary Developments in 2006-07. "Wholesale price inflation was generally within the Reserve Bank's indicative projections of 5.0-5.5 per cent up to mid-November 2006, and rose above the upper end of the band thereafter. The year-on-year inflation was 5.7 per cent as on March 31, 2007 as compared with 4.0 per cent a year ago."

This could be an indication that measures to further tighten liquidity are in the offing as inflation once again crossed the 6 per cent barrier last week.

The document notes that headline and core inflation remained at elevated levels in many economies, including India's, during the first half of 2006-07 reflecting high commodity prices and strong demand conditions, it said.

"Measures of consumer price inflation remained above the Wholesale Price Index inflation throughout the year, mainly reflecting the impact of higher food prices", it noted.

Although headline inflation has eased internationally since August 2006 to some extent, following the softening of international crude oil prices and favourable base effects, it still remains above the inflation targets/comfort zones in many economies.

The RBI maintains that many central banks continued with pre-emptive monetary tightening to mitigate the second round effects, especially in the face of continuing strong demand. "Central banks in emerging market economies also raised cash reserve requirements to address concerns regarding excess liquidity arising, particularly from large external flows", it said.

While the government has cut import duty on several items including cement and edible oils, the RBI has adopted a policy of monetary tightening hiking the cash reserve ratio (CRR) and the repo rate to contain inflation.

While the repo-rate has been hiked by 0.25 percentage points to 7.75 per cent with immediate effect, the CRR has been hiked by 0.50 per cent in two stages of 0.25 per cent each to 6.5 per cent. The first hike has come into effect from April 14; the next follows on April 28.

Both the moves are aimed at tightening liquidity. A hike in the repo rate makes it costlier for banks to borrow from the RBI, which in turn forces them to raise the rate of lending to the final borrower. A hike in CRR is an attempt to suck out excess liquidity from the system.

"The Reserve Bank continued with the policy of gradual withdrawal of monetary accommodation, using various instruments at its disposal flexibly to stabilise inflationary expectations. The Government also took fiscal and supply-side measures to contain inflation", said RBI in its macroeconomic review.

First Published: Apr 23, 2007 20:54 IST