RBI - Mid term review of Annual Policy - Hike in CRR to 7.5%

The RBI Governor, YV Reddy announced the credit policy in Mumbai today.
RBI has hiked the CRR by 50 bps to to 7.5% from 5%. However, the other key rates including the repo and reverse repo rates have remained unchanged. CRR hike may impact in the Indian Capital market.
The RBI's has raised the cash reserve ratio given the persistent rise in capital flows, but has otherwise left other policy rates unchanged. The central bank's main message is that the economy is in fine shape – agriculture is above trend, industry and services may slacken just a bit. So the GDP target remains at 8.5% and inflation at 5%

But the main threat is from global capital flows, which may only increase given easing by global central banks. Inflation, which has been successfully controlled so far, is also under threat from oil and food tightness. But the biggest threat is from capital flows, especially from unregulated private entities who invest in equities and real estate. These, with a lag, can increase aggregate demand and impact inflation.

The central bank's thrust therefore is to control and sterilise flows. Hence the hike in CRR.

Is it more hawkish? It is certainly more alarmist.
The bank rate remains unchanged at 6% while the RBI has kept its inflation target for FY08 at 5%. RBI's GDP forecast too remains unchanged at 8.5%.

The RBI has said that the surplus liquidity needs priority attention. It needs to check bank credit risk from faulty derivative record, it added. Oil companies can hedge forex exposure up to 50% of inventory, it added.

The central bank said that money supply is expanding well above 17-17.5%. There is evidence of stability in real estate prices, it revealed. However, it informed that there are irregularities seen in banks' real-estate exposure.

The RBI has said that 10 banks have high exposure to real estate and stocks, adding that it will continue to manage liquidity through reins like CRR, MSS and LAF (liquidity adjustment facility). RBI said that credit growth is in line with 24-25% target. It confirmed that the credit policy stance has been more hawkish than July; the emphasis being on capital flows.
The Reserve Bank said that that authorised dealers have been allowed to run cross currency options. The total credit growth of 23.3% as on October12 stood at Rs 3.81 lakhs crore, it informed. Managing liquidity arising from forex flows posed a key challenge, it said. The Consumer Price Index (CPI) inflation has been up at 7.3% in August 2007 Vs 6.3% (YoY). The deposit growth is ahead of FY08 target of Rs 4.9 lakhs, the central bank informed.

Companies with forex need can write covered call and puts, the RBI said, adding that excess money supply needs 'intensified monitoring.' It has concerns on strong growth in lending to real estate. Asset prices remain at elevated levels, RBI feels. It finds that currency markets have seen a tentative return to stability.

The global economy is still strong and inflation environment is benign, the RBI has observed. The high oil prices are a concern and food and metal prices will feed inflation, the RBI senses.

Press Release: 2007-2008/589 can be accessed from http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=17429

-- Alagar
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