1. RBII POLIICY UPDATE
R POL CY UPDATE Aug 1, 2007
RBI hikes CRR by 50bps
For the second time in the current year, the RBI has hiked the cash reserve ratio (CRR) by 50bps to
7% effective from August 4. The RBI has clearly articulated its thrust on liquidity management in
its monetary policy. There is excess liquidity to the tune of Rs 50,000- Rs 60,000 crore in the
system and with current hike, about Rs 15,000 –Rs 16,000 crore will be sucked out.
The RBI has maintained its other key rates like reverse repo, repo and bank rate steady. It has
withdrawn the ceiling of Rs. 3,000 crore on daily reverse repo under the LAF with effect from
August 6, 2007. Also, the second LAF session is withdrawn. GDP growth estimate is maintained at
8.5% for FY07-08.
Non-food bank credit growth has moderated to 24.4% from 32% a year earlier with WPI inflation
ranging between 4 – 4.5%. However, the appreciating rupee along with money supply growth at
21.6% continues to be a concern as it is much ahead of the RBI’s targeted zone of 17 –17.5%
levels.
Impact
Banks: Currently banks have excess liquidity and a consequent fall in deposit rates has already
started, but the decline in lending rates that was expected may be deferred on account of the
hike. This may impact banks positively as deposit rates are falling, but lending rates are not,
giving higher spreads. We don’t expect banks’ profitability to be much impacted due to the
current move. Long-term prospects continue to remain robust for the banking sector though
some pressure on funding costs may be seen in H2FY07, when credit off-take rises squeezing
excess liquidity in banks.
Bond Markets: The bond markets are expected to stay at current levels with slightly positive bias.
We expect 10-year benchmark yields to move in the range of 7.8 – 7.9% but yields on the short
end of the yield curve to move up in the near term.
Call Money: We have seen excess liquidity in the system pushing call rates as low as a 0.2-0.5%
too. With the current CRR hike and lifting of the LAF limit of Rs 3,000 crore, we believe call rates to
come close to repo and reverse repo levels of 6 - 7% range giving some returns to banks on their
excess funds.
Our view
The RBI continues to be hawkish on inflation front maintaining its stance of 5% for FY08 and 4 –
4.5% in medium term. Though inflation is in the range of 4 – 4.5%, the rise in crude prices and
certain agricultural commodities globally too keeps RBI thinking on controlling inflation. The hike
in CRR is the best short-term monetary tool to contain liquidity. We expect the current move to be
an indicator of RBI’s move to actively participate in forex market buying dollars and contain rupee
from strengthening further. We believe retail credit growth will taper down with interest rates
continuing to remain high and bank stocks to remain stable in medium term after the immediate
knee jerk reaction on announcement. Though the RBI’s move may appear negative in the near-
term for banks, its objective is to ensure a monetary and interest rate environment that supports
export and investment demand in the economy, along with liquidity management so as to enable
continuation of the growth momentum.
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