RBI Announces Monetary Measures

RBI seeks to contain inflation by hiking CRR and the Repo Rate

The Reserve Bank of India has decided to hike CRR (Cash Reserve Ratio) once again by 50 basis points in two tranches, the first 25 basis points by April 14, 2007 and the balance 25 basis points by April 28, 2007. CRR is the one that the banks have to maintain with itself in the form of cash reserves or by way of current account with the Reserve Bank of India (RBI), computed as a certain percentage of its demand and time liabilities. RBI has also hiked the Repo rate by 25 bps to 7.75% with immediate effect.

The main endeavor of RBI is to keep inflation under check. Inflation as measured by wholesale price index has ruled around 6.5% for the third consecutive week up to March 17, 2007 as per data released today which is way above the upper band of the benchmark set by RBI at 5.5%. The general index of industrial production increased by 11% during April 2006 to January 2007 as against 8.0% a year ago, as per the CSO's release data of March 12, 2007. The move will suck around Rs. 15,500 crore out of the banking system. It clearly indicates that the RBI is not comfortable at the current liquidity scenario in the country, in October & January quarterly
review it hiked the repo rate (the rate at which banks borrow from RBI when they are cash-strapped) each time by 25 basis points and now once again it increases the Repo rate by another 25 bps to 7.75%. It has hiked CRR by 50 basis point each in December 2006 and February 2007 and now it has hiked CRR again by 50 basis points to curb liquidity. To the top of it interest rate on eligible CRR balance is reduced from 1% to 0.5%.
The year-on-year growth in non-food bank credit up to March 16, 2007 was 29.5%, which is well above the RBI’s target of 20% for the fiscal. The year-on-year growth of aggregate deposits was 24.8% up to March 16, 2007, over and above 18% a year ago, seems to be comfortable. With the economy set to grow by around 9%, the central bank is concerned about overheating and asset bubbles building up. This move of RBI will make housing finance companies slow down their disbursements and hike interest rate on home loans. Since property prices are already very high, the increase in interest rate will impact the buyers’ purchasing power that may bring property prices rolling down. Although banks may not immediately increase its PLR, as the
credit offtake during the first half of the financial year normally slows down. Banks will wait and watch over its growth in advances and policy adopted by its competitors before hiking its lending rates.
The margins of the banks would be impacted unless lending rates go up. Going forward the volume growth may calm down to some extent as the lending rates go up. Net profit of banks will be impacted by 2-3% on account of such hike, if banks do not pass on. The yield on the 10-year benchmark government security is expected to rule around 8.10%-8.20%. Interest rate sensitive stocks will see a sharp correction, with banking and real estate shares likely to share the brunt.