So the much awaited credit policy is out and our Reddy "garu" has pulled out some surprises (although not nasty ones).Let us look at some of the fall outs of the policy announced yesterday:

• RBI has told the corporates, banks etc to be "vigilant and well prepared" to deal with higher volatility on the rupee dollar front - which means--- guys I am not going to put too much effort into restricting rupee appreciation - so you guys take care of yourself
  
• This is a good sign ... I have long been of the opinion that too much protection is being given to the exporters - while this was necessary in the early stages of the development - it should have been stopped once our FX reserves touched 200 bnUSD. Moreover the exporters of our country have been pampered to the hilt and should now realise that they should grow up.
• CRR hiked by 0.50 bps to 7%
• This move will suck out close to Rs.13500 crores out of the system - not a major cause of concern for treasuries - because the liquidity floating around in the system is estimated to be around Rs. 1 lac crores. The bond yields reacted yesterday - but this was only a reaction to the announcement and is likely to settle down today. We have seen that the excess liquidity in the system was arising primarily due to the fact that deposits were growing rapidly while advances was showing a declining trend. This coupled with the RBI pumping rupee to support the dollar led to huge liquidity float in the system. Of course the banks will now have to make the effort of pushing advances and reduce costs on borrowings i.e. deposits.
  
• Ceiling of Rs.3000 crores on reverse repo discontinued:
• With the removal of this ceiling the call rates will now gravitate towards this rate which is presently at 6%
• Long term repos to be introduced:
• I have mentioned in my lectures that the short term yield curve is characterised by a zig zag pattern owing to volatility and unpredicability in the short run. With the introduction of 14 day and 28 day repos we might see some smoothening of this segment of the yield curve.
• GDP growth at 8.5%
• This growth has primarily been driven by the services and industrial sector - the farm sector outlook is still uncertain. Like discussed in the class - the RBI is faced with a dilemna of managing a high GDP growth on one hand and reigning inflation on the other.A High GDP together with a monetary system sloshing in liquidity is sure indicator of high inflation in the days to come - this will also result in higher interest rates (this is already indicated by a upward move of the CRR

The coming few months should be interesting as RBI unfolds its plans to tackle the strange situation that India is in now My call - we should see some tightening of the interest rates in the medium term and the RBI is likely to adopt a push pull strategy to control inflation and dollar.

REDDY GOES BOOM:2 : --- (CRR)azy kiya re........

Refer my earlierblog titled : Reddy to go northwards " where I had said that we can look forward to some more turbulent times as far as interest rate scenarios is concerned. It has been proved right by the recent move yesterday by the RBI governor to hike the CRR rates to 6% (from the earlier 5.5%).
The hike will be implemented in two phases of 0.25% each on Feb 17th and March 3rd. The move will suck out a total of Rs.13,500 crores from the system and has been spurred by the RBI's concern over the current trends in inflation which in the recent past has touched 6.8%. What needs to be seen is how far will this move be successful in achieving the goal of inflation supression. Rising commodity prices has been troubling the government for some time now - however what is to be analysed is that how much of the commodity inflation is on account of consumption demand and how much can be attributed to the operations of an erstwhile bull who is now rumored to be playing a big role in the commodities market. If the demand in the other sectors like realty etc does not subside (this may happen if the realty sector continues to rise on account of demand and is not deterred by the high cost of funds) then the prices will go up anyway inspite of the CRR hike. Infact in such a case the CRR hike may spur a disproportionate inflation because the builders will pass on the higher interest burden to the buyers.

The 2nd phase of the hike on March 3 will have a higher impact on short term money rates as the timing of the hike will coincide with year end payments like taxes etc. (though one might argue that there will still be 27 days for the year end and by then the money will be back in the system).

Impact on deposit rates:
The move will benefit the fixed deposit investors as banks are likely to raise the interest rates on term money. We seem to be heading towards days where a double digit interest rate will be a reality after a long time. But the flip side is that consumer loans and housing loans will now become costlier.

Impact on Yields and government securities.
If I were a bond dealer, right now I would be wishing to just run away from this market and rather be sitting on a beach side in Hawai with a lei around my waist. A bond market is the last place I would be wanting to be in today. The yields will take a beating and will move northwards and the longer term securities segment could witness a gory blood bath.

The securities market has been ailing for some time now and this move is likely to pull out the oxygen from the market and leave it gasping for breath. The fall in the prices will affect the mark to market valuations of the banks and the impact will be seen in the banks balance sheet for the ye 31.03.2007.

Impact on corporates:
Corporates now face the prospect of a higher financing costs which is likely to hit the bottom lines and the impact of the same will be mostly felt in the next FY 08-09. Corporates who have borrowed at floating rate will be left holding the short end of the stick.

Stock markets
Banking stocks took a beating yesterday in the light of the interest rate movement northwards. The PSU banks are likely to be the most hit as their ability to pass on the interest rate hike to the consumer will not be absolute keeping in mind their social responsibilities. Moreover as mentioned earlier in this post, the balance sheet of most banks will take a serious knocking on the mark to market process - especially in the longer duration securities. In fact at the time of my writing this blog SBI is trading at 1102 - 6% lower than previous day closing

The road ahead
If the inflation figure stays above 6% then we cant rule out the possibility of further hikes. Rupee will also face some pressure as the rate hike in the long run as continuous rise in the interest rates are perceived as weakening of economy. However in the short run we can see some dollar inflows to take advantages of interest rates arbitrages.

Other steps being taken
The government has decided to ban the exports of wheat to curb the price rise in wheat. But in my opinion the government needs to have a closer look at the factors in play in the Indian commodities markets and curb excessive speculation. It is time that we realise that unregulated speculation in the commodities markets doesnt benefit the farmer in the immediate run and only results in affecting the common man as a consumer who will have to bear the brunt of increased price.