Reddy Dashes Rate Cut Hopes With 0.5% CRR Hike

MUMBAI: First, the bad news. There will be no immediate cut in home loan rates. Corporates may have to pay a little more for short-term money. So will investors borrowing to punt in IPOs. Chances are short-term rates in the money market will harden a little.

But there’s good news for software firms and other exporters hit by the rising rupee. They will have far greater flexibility to cover currency risk on anticipated overseas orders. Also, for the first time, corporates have been allowed to write currency options—a tool that firms with smart treasury operations and right risk appetite can use to protect margins. Moreover, banks will have to explain to home loan takers the rationale behind any rate hike. There could even be a new law on fair lending practices to discipline banks.

However, these are tricky times for banks, bond houses and financial markets. There could be more surprises in store as the Reserve Bank of India (RBI) battles with spiralling money supply. On Tuesday, they got the first dose of monetary tightening as RBI governor Yaga Venugopal Reddy hiked the cash reserve ratio (CRR) of banks by 50 basis points to 7.5%. This will be effective from November 10.

CRR is a slice of customer deposits that banks set aside as cash. Since they earn no interest on the money, a CRR hike is like a tax on banks. More significantly, the measure helps to drain out excess liquidity from the banking system. Tuesday’s hike will lower liquidity (and money supply) by Rs 16,000 crore. This, coupled with the customary cash demand during the Diwali season, may cause some tightening in the money market.

Mr Reddy perhaps feels that more foreign money will flow into stocks and other sectors, particularly after the US Federal Reserve lowers interest rates. The CRR hike is thus a pre-emptive policy step before the domestic financial markets are inundated with fresh inflows.

“We want the financial markets to be prepared for unconventional responses from us to meet unanticipated global shocks. We are going through a positive growth phase and we want this good story to continue. We are prepared to take any action...The problems are unprecedented and the type of measures are unconventional,” Mr Reddy told the media after presenting the policy.

But Mr Reddy will have to grapple with a different problem if inflows turn out to be a fraction of what he anticipates. At that point, he may be forced to cut short-term benchmark rates.