RBI has launched a full out war on inflation. It has raised CRR to 6.5% (from 6%) and Repo rate to 7.75% (from 7.50%). The interest on CRR has been halved to 0.5%. This will hit the banks on two fronts - the banks will be forced to keep more resources with the RBI in the form of CRR (almost to the tune of 16000 crores) and the money so kept will earn lesser interest also. The drop in the CRR rate is likely to shave off Rs.2000 crores from the banks bottomline. In addition to the above move the RBI will mop up a further Rs.6000 crores through the market stabilisation scheme. The above steps would make the cost of funds for the banks to go up which would force them to increase the lending rates.

It is widely perceived that an unbridled growth in M3 is the cause of such inflation. Reacting to the news the call rates shot up to 80% yesterday and the bond yields have gone up substantially. The 10 year benchmark government securities was being dealt at slightly less than 8% and the chances are that on Monday it will rise further. The fall happening on the last trading day of the fiscal is likely to have an impact on the balance sheet of most of the banks as they will have to make higher provision for depreciation in their bond portfolio.


The scenario for the first half of the next fiscal also doesnt seem to be too bright - In the first half the government will raise Rs.92,000 crores via issue of government bonds out of which more than 20000 crores will be through issue of bonds with maturity of more than 20 years


The rupee dollar front also seems to be witnessing high volatility with rupee touching 43.78 to a dollar before settling down to 43.45 at the close yesterday. This surge in rupee in the last week is sure to knock off the pants of exporters for whom such a move is a direct hit on their bottom line.

On the corporate front, we might witness a surge of corporates borrowing abroad in foreign currency to access cheaper funds. This will no doubt add to the already swelling forex kitty which is expected to touch 200 bn $

Be ready for further hikes in the interest rates in the near future!!!!

CALL RATES / RUPEE - DOLLAR MOVEMENT

On 20th of this month the call rates shot up to 70% (even though this was on stray deals). The reason being attributed to this is the liquidity crunch arising out of advance tax outflows. However, I feel that this stray spike in the call rates is no indicator of long term fundamentals on the interest rates. It was just a single day anamoly and should be treated as such. I have time and again reiterated the necessity of a strong banking system for capital account convertibility. However the banking systems' state on tuesday only shows the immaturity of our banking system. Normally there is a liquidity crunch at the end of every quarter when the corporates pay advance tax. This crunch is even more pronounced during the last instalment to be paid in March. Keeping in mind the kind of bottom line growth the corporates have been posting during the last year, any sane person would have known that tax outflows for the FY 2006-07 would also be very high. Hence some tightening should have been expected and the banks should have prepared themselves beforehand. Moreover remember in my previous blog on CRR I had mentioned that the last tranche of CRR hike would result in some tightness as it would immediately follow the tax outflows. Had the banks carefully planned their cash flow positions they need not have pressed the panic buttons and let the call zoom to such rates.

Foreign banks and the new generation private sector banks, in their drive to maximise profits, are overstretching themselves by lending much in excess of their deposits. The excess lending is financed through short term borrowings (including call).These banks would have no option but to keep borrowing irrespective of the rates to fund their lending. This is what is called as asset liability mismatch. While this mismatch might yield good profits under normal situation, however when there are sudden spikes in the short term rates it could create problems for the banks.

Rupee Dollar Movement
We have been studying this in MAFA. Now you can see this happening in real life. Rupee has appreciated from 44.25 to a $ on 22nd February to 43.45 to a $ yesterday. Clearly this would hit the exporting companies very hard. The dollar proceeds received by such export companies would now realise much less than what it would have realsied on 22nd February. (Except of course for people who had taken forward cover). This appreciation of rupee vis a vis the dollar will straight away knock off a significant portion of the top line as well as bottom lines of such companies. Of course exporters who have planned and seasonal exports wont be hurt much as they would have taken forward covers but for industries which thrive on spot orders (especially commodities) the hit would be higher.

One can see a linkage between the rupee dollar movement and the call money rates. As the call rates shot up treasury managers would have sold dollar and bought rupee resulting in the dollar depreciating vis a vis the rupee.

US Fed keeps interest rate unchanged
The US Fed did not change the interest rate and kept it unchanged at 5.25%. So possibly we can also heave a sigh of relief and hope for some respite from the continuosly increasing interest rates. PM Manmohan singh on Wednesday played down the fears of overheating in the economy, saying rise in inflation rate is a temporary phenomenon as growth impulses in India are very strong.