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.

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.