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RBI Raises CRR, Holds Key Rates

The jump by 75 basis points (bps) will happen in two stages, taking it to 5.75 per cent

The Reserve Bank of India (RBI) today raised the cash reserve ratio (CRR) for banks by 75 basis points (bps), but left key interest rates unchanged. The Repo rate is unchanged at 4.75 per cent, Reverse Repo rate at 3.25 per cent and the Bank rate at 6 per cent. The CRR will be lifted by 50 bps (February 13) and by a further 25 bps (February 27) to 5.75 per cent.

Inflation continues to be a cause for concern with the baseline projection for WPI inflation (end March 2010) raised to 8.5 per cent, up from 6.5 per cent. The RBI believes that inflation should start to moderate from July, assuming a normal monsoon and steady global oil prices.

Naturally, the stance of monetary policy for the remainder of 2009/10 will be to anchor inflationary expectations, keep a vigil on trends in inflation, and respond swiftly and effectively through policy adjustments as warranted. To balance growth, the RBI will also actively manage liquidity to ensure that credit demands of productive sectors are adequately met consistent with price stability.

Here are some reactions from fund managers...:

Arvind Chari, Fund Manager – Debt, Quantum Mutual Fund. 

No major changes expected in long bond rates. That will take cue from the Budget and on the possibility of the 3G auction money coming through this fiscal.

Inflation target revised upwards is a thing to take note of.

CRR hike of 75 bps is higher than expected. Liquidity will tighten more than what the market expects. Mutual funds will face redemptions from banks. Short term rates to inch upwards.

Leaves a possibility of an inter–meeting rate hike in February/March.

Bankers would have preferred rate hikes over a high CRR. But no major changes expected in lending rates.

RBI seems quite assured of the recovery.

Overall, a calibrated ‘EXIT’.

Ramanathan K., CIO (Single Manager - Investments), ING Investment India

A 75 bps hike in CRR was only marginally above the market expectation of 50 bps. No changes in the reverse repo and repo rates were in line with expectations. The RBI continues to delicately balance the need to return to a neutral policy on the back of increasing inflationary expectations and the need to nurture further domestic recovery on the back of a weak, stimulus-driven, global economy. We continue to expect that the RBI would cumulatively increase reverse repo and repo rates by 100-150 bps over CY2010. One could also expect more measures to drain out excess liquidity (either through CRR increases or MSS issuances) if capital flows continue to be strong.

Ashish Nigam, Head Fixed Income, Religare Mutual Fund

75 bps hike in CRR was more than expected, but is unlikely to impact the long bond yields adversely as most of it was factored in the bond prices. Since the liquidity in the system is easy, 75 basis points (in two phases) is not expected to push up short-end rates also. Key 10Y benchmark bond yields could move in the range of 7.50 per cent to 7.70 per cent. Leaving policy rates unchanged clearly reinforces RBI's stance that it will balance between economic growth and inflation. RBI is taking cognizance of the fact that inflation is supply-side driven, by revising the inflation target from 6.50 per cent to 8.50 per cent. Any policy rate changes are expected in April policy.

Alok Sahoo, Head of Fixed Income, Baroda Pioneer AMC 

RBI has shown more concern on anchoring inflation, which is evident from its policy stance. We feel that inflation by March-end may be higher than 9 per cent, above RBI’s baseline expectation. We expect RBI to hike policy rates from April 2010. The short-term interest rate would move up due to reduction in liquidity from the system. The yield curve to flatten, with upward movement. The long-term interest rate is not under pressure till March due to lack of supply of government bonds. However, large government borrowings in first-half of FY 11 may be challenging due to high inflation, lower liquidity and private credit demand.

...And by a banker:

Moses Harding, Head-Global Markets Group, IndusInd Bank

RBI delivered on expectations with a tinge of surprise by hiking the CRR by 0.75 per cent, thus sucking out around Rs 36,000 crore against the expectation of Rs 25,000 crore, which is anyway not an unpleasant surprise given the current excess liquidity of over Rs 70,000 crore. The revision of GDP forecast to 7.5 per cent and inflation projection to 8.5 per cent reflects the current economic fundamentals. The action has also validated the liquidity management concerns of RBI to avoid opening up of carry-trade foreign currency supplies into Indian markets. 

It is back to business as usual to ensure price stability and await the drain of excess liquidity from the system to trigger rate actions if inflationary pressure continues to remain valid. Government's supply-side actions and good monsoon would help to guide soft-landing of inflation below the set target as the base effect also would come into play in due course. It is good run for borrowers as they would continue to enjoy the low interest rates in the short term and banks would be in a position to preserve the Net Interest Margins despite locking in additional amount with RBI at zero per cent. 

Overall, it is a good move by RBI with the surprise element signalling its concerns on liquidity management and arresting inflationary pressures.