VZCZCXRO5054
PP RUEHAST RUEHCI RUEHDBU RUEHLH RUEHNEH RUEHPW
DE RUEHBI #0041/01 0341135
ZNR UUUUU ZZH
P 031135Z FEB 10
FM AMCONSUL MUMBAI
TO RUEHC/SECSTATE WASHDC PRIORITY 7714
INFO RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHCG/AMCONSUL CHENNAI PRIORITY 2202
RUEHCI/AMCONSUL KOLKATA PRIORITY 1989
RUEHNE/AMEMBASSY NEW DELHI PRIORITY 8924
RUEHBI/AMCONSUL MUMBAI PRIORITY 2955
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SECTION 01 OF 03 MUMBAI 000041 
 
SENSITIVE 
SIPDIS 
 
DESK PLEASE PASS TO USTR 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EIND EINV IN
SUBJECT: RBI MOVES AHEAD OF THE CURVE TO SIGNAL INFLATION 
EXPECTATIONS 
 
MUMBAI 00000041  001.2 OF 003 
 
 
¶1.  (U) Summary: On January 29, the Reserve Bank of India (RBI), 
India's central bank, raised the cash reserve ratio (CRR), its 
first direct step towards monetary tightening in an effort to 
fight rising inflation, which the RBI now expects to be 8.5 
percent for the fiscal year.  The belt tightening would withdraw 
$7.8 billion of the current $15.17 billion liquidity from the 
banking system.  However, neither the central bank nor bankers 
expected this hike to have any immediate impact on lending rates 
or on growth, as the RBI dramatically revised its projection for 
2009-10 for GDP growth to 7.5 percent from its previous 6.0 
percent.  Acknowledging the risk of a large fiscal deficit, the 
central bank also urged the Indian government to implement 
fiscal discipline measures.  RBI noted that the reversal of 
monetary actions would not be effective unless there is a roll 
back in government borrowing.  End Summary 
 
 
 
RBI Takes First Monetary Step Towards Tightening 
 
------------------------------ 
 
 
 
¶2.  (U) On January 29, the Reserve Bank of India (RBI), India's 
central bank, took its first direct step to tighten monetary 
policy in its third quarter monetary review.  The RBI 
aggressively raised the CRR (the percentage of deposits which 
must be kept with RBI) by a more than expected 75 basis points 
(bps) to 5.75 percent.  The market consensus view expected a 50 
bps hike.  The CRR hike will be implemented in two stages -- a 
50 bps increase effective February 13 and the remaining 25 bps 
beginning February 27.  This move cumulatively will suck out 
$7.8 billion of the current $15.17 billion liquidity from the 
banking system.  Other policy rates -- the repo (the interest 
rate at which RBI lends to banks) and the reverse repo rate (the 
interest rate RBI pays to banks for funds deposited with it) -- 
were kept unchanged, in line with market expectations.  In its 
previous policy review of October 2009, the RBI had announced 
terminating some sector-specific facilities and restoring the 
statutory liquidity ratio (the proportion of bank liabilities 
held in government securities) to the pre-crisis level. 
 
 
 
¶3.  (U) The RBI Governor, Dr. D Subbarao, noted that the CRR 
hike would definitely raise the cost of funds for banks, but 
that banks had assured the RBI that lending rates would not go 
up immediately and generally supported the move.  O.P. Bhatt, 
Chairman of the government-owned State Bank of India (India's 
largest bank) told the media that the CRR hike will not have a 
significant impact on interest rates.  However, Bhatt added, 
corporate borrowing rates could rise.  Aditya Puri, the Managing 
Director of HDFC Bank, said that even if interest rates increase 
after six months, it would be in the range of 0.5-0.75 percent. 
This increase, Puri thought, would not impede credit growth. 
 
 
 
RBI Raises Growth and Inflation Forecast 
 
---------------------------------------- 
 
 
 
¶4.  (U) The RBI raised both its growth and inflation forecast 
for 2009-10 in its policy review.  In the October 2009 monetary 
policy review, RBI had projected 2009-10 GDP growth at 6.0 
percent, with an upward bias.  "Assuming a near zero growth in 
agricultural production and continued recovery in industrial 
production and services activity, the projection for GDP for 
2009-10 is now raised to 7.5 percent", the RBI determined.  On 
revising growth targets dramatically, Governor Subbarao listed 
the positive prospects of a better-than-expected winter crop, a 
stronger industrial and export recovery, and a revival in 
consumption and investment.  On the inflation front, citing 
rising commodity prices globally and the domestic demand-supply 
balance, the RBI raised its inflation projections as measured by 
the Wholesale Price Index (WPI) for March 2010 to 8.5 percent, 
up from 6.5 percent. 
 
 
 
¶5.  (U) In the third quarter review of Macroeconomic and 
 
MUMBAI 00000041  002.2 OF 003 
 
 
Monetary Developments, a report which serves as a background to 
the review of monetary policy, the RBI noted the difficulties in 
using monetary policy measures to address rising food price 
inflation and supporting the return to high growth.  In December 
2009, WPI-measured inflation was at 7.3 percent; excluding food 
articles, WPI-measured inflation was only 2.1 percent, 
accentuating the concentrated nature of inflation.  But the RBI 
also warned of the risk of food price inflation transmitting to 
other non-food items through expectations-driven wage and price 
revisions, which may translate into a generalized inflation. 
The RBI acknowledged, however, that the monetary policy tools in 
its purview are limited in their impact, and can only address 
liquidity factors causing inflation, and not the rise in food 
prices, per se. 
 
 
 
RBI Calls for Fiscal Prudence 
 
---------------------------- 
 
 
 
¶6.  (U) In its monetary policy review and the subsequent press 
statement, the RBI urged the government to implement fiscal 
discipline measures.  The RBI acknowledged that "by far a bigger 
risk to both short-term economic management and to medium-term 
economic prospects emanates from the large fiscal deficit."  In 
2008-09 and 2009-10, government borrowing increased 
significantly, reached a record USD 92.53 billion this fiscal 
year.  In the meeting with the RBI subsequent to the policy, 
banks noted that if the government borrowings continue to remain 
large, it would put additional pressure on resources and 
interest rates.  This borrowing was managed by the RBI through a 
host of liquidity measures, including buying back bonds and 
unwinding short-term debt bonds.  However, the RBI warned that 
such liquidity infusion options would not be available to the 
same extent next year.  Moreover, with expectations of strong 
growth in private credit demand, RBI said there is a threat of 
public borrowing crowding out companies in needs of funds. 
Therefore, the RBI pointed out a need for co-ordination between 
the central and the GOI in their fiscal and monetary exit plans. 
 
 
 
 
RBI Revises Bank Credit Growth 
 
------------------------------ 
 
 
 
¶7.  (U) The RBI in its policy report reduced the non-food credit 
growth from 18 percent to a realistic 16 percent.  Chanda 
Kochhar, MD & CEO, ICICI Bank said that the RBI had undertaken a 
fair assessment of credit growth.  The banking sector has 
achieved about a 14 percent growth in the first nine months and 
therefore the initially RBI-indicative 18 percent growth was 
unlikely to be achieved, she added.  Nevertheless, she did 
foresee credit growth picking up considerably in the next fiscal 
year.  Bankers present at the release of the policy report 
reiterated that credit growth prospects remained favorable going 
forward.  They emphasized the need to expand their capital base 
for sustained future lending.  Bankers were also concerned about 
the growing bank exposure to the infrastructure sector and the 
need to address the issue of asset-liability mismatch.  They 
requested for an appropriate policy intervention both from the 
government and RBI. 
 
 
 
RBI Conducts First Ever Teleconference 
 
--------------------------- 
 
 
 
¶8.  (U) The RBI Governor and Deputy Governors for the first time 
held a post-policy conference call with researchers and analysts 
to improve dissemination of its viewpoint and also to receive 
direct feedback.  Apart from reiterating what had been said in 
the pre-policy macroeconomic review and the main monetary 
policy, the RBI board calmly responded to market participants' 
queries.  The RBI accepted that bank lending to infrastructure 
 
MUMBAI 00000041  003.2 OF 003 
 
 
is indeed high, but suggested various mechanisms -- including 
bank syndication and corporate bonds - that could be used to 
meet infrastructure funding needs without breaching the single 
or group borrower exposure norms.  On the issue of capital 
inflows, Governor Subbarao said that if the inflows were far in 
excess of the current account deficit, only then would measures 
such as lowering non-resident Indian deposit rates or increasing 
restrictions on external commercial borrowing and foreign 
institutional investor exposure to government and corporate debt 
be considered.  Regarding Non-Performing Loans (NPL), the RBI 
claimed that the loan restructuring scheme had averted a marked 
increase in NPLs.  However, they needed to wait for another 
quarter to get a concrete view on how much of the restructured 
loans would turn into NPLs.  So far, the feedback from banks 
suggested that this would not become a serious problem, the RBI 
said. 
 
 
 
¶9.  (SBU) Comment:  This monetary policy review represented a 
challenge to the RBI and its views on growth and inflation.  The 
RBI recognized the need to begin draining excess liquidity in 
the system, but feared that too severe move - such as raising 
policy rates -- would dampen India's rapid return to high 
growth, now in full progress.  The CRR hike was a relatively 
painless and expected move, in line with the logic of its 
monetary reviews.  The move confirms that the RBI has shifted 
its direction, and more tightening could be ahead if concerns 
over inflation begin to outweigh the benefits of growth.  End 
Comment. 
FOLMSBEE