India’s central bank, the Reserve Bank of India (RBI), today, hiked the Cash Reserve Ratio for Indian banks by 50 basis points (0.50%) in a bid to rein in money market liquidity (Press release here).
The CRR is the amount of cash (expressed as a percentage of net demand and time liabilities - deposits to a layman) that banks have to keep as clear cash balances with the RBI. Banks do not earn any interest on these balances. This hike is to be implemented in two stages of 0.25% each with effect from Feb 17, 2007 and March 3, 2007. The total amount of cash that would be impounded by this is estimated to be INR 140 bn.
This move is in line with RBI’s stated stance of reining in inflationary expectations, and also its willingness to use all tools at its disposal at any point in time. What comes as a bit of a surprise to some, though not seasoned marketmen, is that this comes within a fortnight of the release of the last quarterly review of the monetary policy. However, to marketmen, there were enough indications that some such move was in the offing, given the easing that we have witnessed in the liquidity situation in the money markets during the last week or so.
More importantly, the direct move of impounding cash, is a strong message to banks to curb unrestrained lending, especially to red hot sectors like commercial real estate and capital markets. A related impact of the central bank’s move would be a rise in costs for banks which they would most likely pass on to their customers. Indian corporates and consumers therfore have to brace up to more hikes in lending rates
The immediate impact on the bond markets is clearly bearish, though the market may find some support since bank’s statutory investment in government bonds are running very close to the minimum 25% (of net demand and time liabilities again) that they need to maintain. We would therefore not be witness to a bout of unrestrained sales as would normally have been the case in such a situation otherwise. Further, many marketmen were expecting some such move, which may limit the damage to some extent.
Money market rates are expected to firm up in sympathy with the RBI move. Bank stocks are also expected to open in the red when trading opens on the National Stock Exchange of India and the Bombay Stock Exchange.