Monetary conditions too tight for RBI rate hike

Monetary conditions in the banking system have been so tight that the central bank will have to refrain from raising rates this week despite inflation being above comfort levels and at risk of trending higher.

From credit-deposit ratios in the system to the huge amounts of cash banks are having to borrow each day from the Reserve Bank of India (RBI), most indicators point to a huge cash deficit in the banking system.

The RBI has been using ad hoc open market operations, barely enough to curb market, and market players reckon it will be a while before the tax payments and other surpluses lying in government coffers are back in circulation.

The RBI governor said last Thursday that the government's cash balances with it stood at around 910 billion rupees $20.2 billion) from 777.36 billion rupees as on Oct. 31.

A deputy governor at the central bank had said at last month's policy review that the RBI was comfortable with either a deficit or surplus of around plus/minus 1 percent of deposits -- roughly 500 billion rupees. But daily borrowings by banks have been about 1 trillion rupees on an average since November.

An increase in currency in circulation during the festival season from October and low government spending are the key reasons for tight liquidity, while high inflation has led to the public holding more cash for spending as expenses mount.

The headline inflation in November stood at 7.48 percent, above the central bank's 5.5 percent projection by next March when the current fiscal year ends, after staying in double-digits for six straight months through July.

A slowdown in the pace of foreign fund inflows has also reduced the dollar funds with banks adding to the cash tightness.

CREDIT GALLOPS, DEPOSITS DWINDLE

Loan growth accelerated this year as banks extended lending to telecoms for wireless spectrum auctions held in May. But with deposit rates lagging inflation, the RBI at its November review said there was room for raising deposit rates.

BANK BORROWINGS, SHORT-TERM RATES SPIKE

Banks have been borrowing heavily from the central bank through its reverse repo window. Short-term rates also spiked in response to the tight cash conditions with the 1-year OIS rising as high as 7 percent, its highest in 26-months, last week.

($1 = 45.3 rupees)

(Editing by Malini Menon & Kazunori Takada)