Reserve Bank of India Inflation ?? Again ??

Banks’ overnight borrowings from the Reserve bank of India (RBI) hit a new record of Rs 1.91675 lakh crore, reflecting the intense cash squeeze in the financial markets and prompting bankers to expect a cut in the cash reserve ratio (CRR) even before the review of monetary policy on March 15.

Liquidity has dried up mainly because of RBI’s dollar sales from the market to support the local currency that was losing its value fast against the dollar. RBI, between September and December, sold $12.5 billion (around Rs.61,500 crore today) in the market to stop a rapid depreciation of the rupee. Besides, it also sold close to $3 billion in the forward markets.

CRR is the percentage of total deposits that banks are supposed to keep with the RBI. RBI has cut CRR by 50 basis points to 5.50 per cent on January 24 to infuse additional liquidity in the banking system. Reduction of 50 basis points cut in CRR will pump in Rs 32,000 crore.

“The RBI is in liquidity-injection mode given the tightness in cash conditions,” Tushar Poddar and Prakriti Shukla, Mumbai-based economists at Goldman Sachs Group Inc., wrote in a research note today.

The yield on the 8.79 percent notes due in November 2021 rose one basis point, or 0.01 percentage point, this week to 8.23 percent as of 9:44 a.m. in Mumbai, according to the central bank’s trading system..

The central bank cut the amount of deposits lenders must set aside as reserves to 5.5 percent from 6 percent on Jan. 24, the first reduction since 2009. The RBI will lower the ratio by a further 100 basis points in the fiscal year ending March 31, 2013, the Goldman Sachs’ economists wrote, compared with an earlier estimate of 50 basis points.

The central bank has hiked rates 13 times, or by 350 basis points, since March 2010. Yet most economists don’t expect rate cuts of more than 100 or 150 basis points in the next financial year. Indeed, a recent Macquarie report warned that India could face an ‘oil shock’, which could push up inflation again and prematurely stall the rate-easing cycle.

The only way the RBI can slash rates aggressively is if the government reins in its excessive spending (the fiscal deficit is expected to exceed 5.5 percent of GDP in the current financial year ending March 2012) and announces measures to boost investments in supply side infrastructure.

If not, we may as well get used to higher inflation, high interest rates and slowing growth for a long, long time.