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.