CRR Hike May Be Around The Corner As Liquidity Jumps

MUMBAI: Fears of a hike in the cash reserve ratio (CRR) are resurfacing. While the banking system is once again flooded with surplus cash flows, price levels too are rising to newer highs. All these have led to fears of monetary measures by RBI including a hike in CRR.

Banks on Friday parked surplus funds worth Rs 37,000 crore with the central bank at the daily reverse repo window. On the other hand, the wholesale price index (WPI) accelerated to 7% in the 12 months ended March 22, 2008, sharply higher than the previous week’s 6.68%. Last week, price levels had risen to 6.68% levels, which gave rise to fears of policy action from the monetary authorities. Given that inflation figures have risen further this week, it has increased chances of a rate hike.

A senior bond dealer with a private sector bank said, “With inflation rising to 7%, the probability of the central bank taking monetary measures has gone up considerably. There is a strong case for RBI to take immediate action, even though it might prefer to wait till the policy statement. There are two options with the central bank: raising CRR or tinkering with repo and reverse repo rates.”

He added that a hike in CRR would mean a temporary sucking out of excess liquidity from the system, whereas tinkering with repo or reverse repo rates would signal hardening of rates. Standard Chartered Bank managing director and regional head (south Asia, capital markets) Prakash Subramaniam said, “It’s more likely the central bank would tighten the monetary situation first by hiking CRR, which would drain out surplus funds in immediate future. The central bank may not tinker with key rates for now.”

Market participants feel it would be better if RBI adopts a wait-and-watch stance to see the measures adopted by Centre to combat inflation. Again, if key rates are hiked, it would widen the corridor and give way for more foreign fund inflows, putting pressure on the rupee to rise against the dollar.

Citi has said in a report: “Monetary tightening is unlikely to bring down current levels of inflation. However, inflation is well above RBI target level of 5%. This, coupled with its focus on inflationary expectations and there being little room for rupee appreciation (as capital flows are decelerating), may translate into a policy response.

Thus, at this stage, the lesser devil would be tinkering with CRR rather than the policy rate and justifying it on the basis of the government’s surplus cash balances estimated at Rs 80,000 crore, which will likely come into the system in the coming weeks”.

Voicing a slightly different stance, HDFC Bank treasurer Sudhir Joshi said, “RBI is likely to react to the high liquidity conditions by raising CRR, but only in the policy statement. No indicative action is expected in two weeks. For the entire month of March, cash conditions were under severe pressure on account of advance tax payments and year-end requirements. Call rates had risen to as high as 9% levels while RBI had announced a couple of extra repo windows to infuse funds into the system. In October 2007, the central bank had hiked CRR by 50 bps to 7.50%, effective fortnight beginning November 10, 2007. Prior to that, the CRR was hiked thrice between December 2006 and March 2007.”

Market Sentiment Points To Imminent Hike In CRR

MUMBAI: Spiralling prices at the close of the financial year have turned out to be bad news for bond markets. Reacting sharply to the annual inflation figure rising to 6.68% levels, prices of government bonds dipped to three-month lows.

The yield on the benchmark paper, the 7.99% bond maturing in 2017, rose to 7.89% during the day. The yield ended the day at 7.91%, well above Thursday’s 7.78% close, and its highest close since November 30, 2007.

Going forward, yields are expected to breach the 8% mark in the near term given the finance minister indicated that RBI would take measures to curb inflation. This has triggered widespread speculation about a possible hike in the cash reserve ratio (CRR). Yields could also come under pressure in April once the government borrowing programme kicks in.

RBI deputy governor Rakesh Mohan told mediapersons in Ahmedabad the central bank aims to contain inflation at 5%. The statements of the finance minister coupled with the response of RBI deputy governor has led to expectations that RBI may announce tightening of measures ahead of its monetary policy scheduled for April-end.


Standard Chartered Bank head (fixed income trading) Manoj Swain said, “Inflation has zoomed past well ahead of bond traders’ estimates. It is certainly way out of RBI’s comfort zone. This would surely make a case for tightening the monetary stance of the central bank. The rising price levels would prompt RBI to keep cash conditions on a leash till the annual policy review is announced on April 29.”

Volumes in the government bond market were seen dwindling for the past week as traders were wary of a rate action from RBI. The banking system is also reeling under the impact of a severe cash crunch. On Friday, banks borrowed Rs 20,000 crore from the central bank at the daily repo window.

ICICI Bank chief economist Samiran Chakraborty said, “Rising price levels is not an India-specific phenomenon. It has been a global trend, which calls for policy action on the fiscal and trade front in India. The task before the central bank is to prevent the rising price levels from raising inflationary expectations through its monetary policy action.”

In its latest report on market outlook, JP Morgan has forecast the central bank is likely to favour tightening money market liquidity over a rate hike and outsized currency appreciation. Similarly, Goldman Sachs, in its weekly report, brushed aside all hopes of a rate cut.

“The spike in inflation removes nearly all possibilities of a rate cut and, indeed, has increased the probability of a rate hike. However, we think RBI will not hike rates in its next meeting on April 29 as demand is slowing, credit growth moderating and the run-up in inflation is more supply side- and global commodity-driven,” the report added.

RBI Keeps Rates Unchanged

The Reserve Bank of India has kept rates unchanged in its Credit Policy review on Tuesday. Cash Reserve Ratio (CRR) remains unchanged at 7.5 per cent, while the repo rate, the rate at which the RBI borrows from the banks, is held steady at 7.75 per cent. The bank rate and the reverse repo rates have also been held steady.

Announcing the Policy, RBI Governor Dr Y V Reddy stated that the policy endeavor would be to contain inflation close to five per cent in 2007-08. He also stated that liquidity management would assume priority in the conduct of monetary policy through appropriate and timely action. The policy review that seeks to condition inflationary expectations in the range of 4 - 4.5 per cent comes within days of Finance Minister P Chidambaram''s statement that he would be sunk in case there was a high inflation, along with high economic growth.