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.


4 Responses to “”

  1. 1 Rohan February 15, 2007 at 9:09 am

    RBI had raised interest rates on Jan 31. And if I am not wrong, I think there is always a lag effect of interest rate hikes on inflation. So a CRR hike was not warranted. The RBI should have waited for the effects of the interest rate hike on inflation. A CRR hike is just going to create a burden for the banks. In Dec and first half of Jan when liquidity was tight, RBI was pumping money into the system. Now that same money is going to be sucked out due to the CRR hike. So RBI shouldn’t have pumped money into the system in the first place.

    Inflation for week ended Feb 3 was at 6.73%. But this is mainly on account of lack of supply of primary goods which have inelastic demand. So any amount of monetary adjustment is not going to affect the demand for these basic commodities which are short in supply. Agricultural sector is growing at a mere 2%. Moreover rising interest costs may burden the already troubled agricultural sector.

    The better option could be to control government spending. The government revenues have risen substantially in the current financial year. It would be prudent on part of the government to achieve its FRBM targets in advance. Our government is used to big fiscal deficits. If it has 100Rs it spends 120. If it has 120Rs it spends 150. If government controls its spending, the fiscal deficit will reduce which in turn will bring down inflation.
    Controlled government spending will also slow down the economy bringing down inflation further.

    The interest rate hike and CRR hike might cool down real estate prices and reduce consumption which in effect might bring down inflation expectation. Which is exactly what RBI wants. But in the process the growth of the economy should not be compromised.

  2. 2 Srini February 15, 2007 at 10:25 am

    good analysis rohan — keep the good work up … now you are getting the hang of it.
    The next time try reducing the text to points basis — this will enable you to analyse things better and improve your presentation skills.

  3. 3 amritakelkar February 19, 2007 at 5:24 pm

    sir i am a bit confused abt this….CRR rate hike….
    Inflation was around 6.80% in first week of Feb…The inflation was a demand pull inflation…so assuming there was more liquidity in the economy RBI raised the rates…
    But why did RBI increase CRR rates to reduce inflation?..there are other techniques also…how does RBI decide which technique to follow?..
    Say for instance, govt reduced petrol & diesel prices to control inflation…thn why not just tht….they reduced prices just to reduce inflation or was there some political purpose behind it…was reducing petrol prices not enough for them…Reduction in prtrol prices will reduce rising prices which will help solve the purpose…
    Also they have increased interest rates prior to this …why would they do tht as this might affect banks at the year end?
    Also they are implementing it in two phases 0.25% in each phase…why not in one shot?…wat are the disadvantages of incresing the rates in one shot as all were expecting the hike?…
    Any other ways which can control inflation…
    Sir u also told tht if there is a demand thn there will b no effect on real estate prices …thn it will automatically increase inflation na…
    plz sir i need clarification as i am lost….

  4. 4 Srini February 20, 2007 at 4:49 am

    Inflation can never be controlled with the help of one single measure – it has to be a combination of measures acting in tandem that will bring down inflation.
    Yes, reducing petrol prices is one way of doing but it is not the only way. What the government has done is backed this up by increasing CRR.
    So it is attacking inflation from 2 sides – demand as well as supply. Demand by increasing CRR and increasing supply by steps like reducing exports of wheat.
    Any CRR hike especially of the magnitude of 50 basis points will always be implemented in stages – the system cannot sustain an overnight drainage of 14000 crores.
    With the curtailing of money available the demand for a lot of goods will come down as people will postpone consumption – so on one hand it will bring down inflation but it will also affect the corporates to some extent – hence it is a double edged sword.
    However whether demand for a particular commodity goes down will depend upon its elasticity. Real estate demand , right now as predicted by many pundits is inelastic – i.e people are going to invest irrespective of the interest rates.. in which case the builders will be able to pass on the effect of the interest rate hike to the ultimate investor

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

Admission open for Nov ‘2010 exams

Admissions have already opened for Nov 2010 exams. We offer only 45 seats for a batch and admissions have already started filling up with only 10 seats remaining

Batch for May 2010

Classes scheduled to start from February 2009 for May 2010
February 2007
« Dec   Mar »



%d bloggers like this: