January 29, 2010

RBI Monetary Policy 29 Jan 2010

Before we embark on understanding the nuances of the monetary policy review, we try to briefly understand the terminologies and jargon related to the same.

What is Monetary Policy?
The regulation of the money supply and interest rates by a central bank, such as the RBI in India, in order to control inflation and stabilize currency. Monetary policy is one the two ways the government can impact the economy. By impacting the effective cost of money, the RBI can affect the amount of money that is spent by consumers and businesses.

Monetary Vs. Fiscal Policy



Monetary Policy Tools & their relevance in impacting liquidity
CRR means Cash Reserve Ratio. Banks in India are required to hold a certain proportion of their deposits in the form of cash. However, actually Banks don’t hold these as cash with themselves, but deposit with RBI / currency chests. Thus, when a bank’s deposits increase by Rs100, and if the CRR is 9%, the banks will have to hold additional Rs.9 with RBI and Bank will be able to use only Rs. 91 for investments and lending / credit purpose. Therefore, higher the ratio (i.e. CRR), the lower is the amount that banks will be able to use for lending and investments. It is an instrument in the hands of central bank through which it can either drain excess liquidity or release funds needed for the economy from time to time.

Bank Rate: This is the rate at which RBI lends money to other banks or financial institutions. If the bank rate goes up, long-term interest rates also tend to move up, and vice-versa. Thus, it can be said that in case bank rate is hiked, in all likelihood banks will hikes their own lending rates to ensure and they continue to make a profit.

SLR stands for Statutory Liquidity Ratio. This term is used by bankers and indicates the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of cash and some other approved to liabilities (deposits). SLR regulates the credit growth in India.

Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the banks. When the repo rate increases borrowing from RBI becomes more expensive. Therefore, we can say that in case, RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate. Similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the RBI. The RBI uses this tool when it feels there is too much money floating in the banking system. An increase in the reverse repo rate means that the RBI will borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep their money with the RBI

A Policy review statement has typically 4 sections
• Section I - Overview of global and domestic macroeconomic developments
• Section II – Provides outlook and projections for growth, inflation, money and credit aggregates
• Section III - Stance of monetary policy
• Section IV - Specifies the monetary measures

Key Highlights of Monetary Review Policy
• CRR hiked by 75 bps to 5.75%, increase to be conducted in 2 phases – 50 bps w.e.f Feb 13, 2010 and 25 bps w.e.f Feb 27, 2010. Eventually, this will drain out Rs 36,000 crore from the system.
• RBI kept the reverse repo rate unchanged at 3.25% and repo rate at 4.75%
• Projected the GDP growth for financial year 2009-10 at 7.5% from 6% last year; Inflation to be at 8.5% in March
The CRR hike comes on the back of spiraling inflation. Food inflation touched 17.4 per cent, fuel price index rose to 5.7 per cent while primary articles price index touched 14.66 per cent for the week ended 16 January 2010. The WPI-based inflation, rose from sub-zero level last year to 7.3 per cent in December.

Impact Analysis
Markets tanked momentarily as a knee jerk reaction, however, regained stance. The CRR hike was inline with the expectation of the market and hence, it was pre-dominantly factored in earlier. This was the first of the initiatives to reverse the stimuli which has been in the market since Oct 2008. Reduction of liquidity will help anchor inflationary expectations. Taking a cue from RBI's monetary policy stance, banks might not hike their auto, home and education loans in the near term. Increases in CRR could push bond yields up, and weigh on shares of banks as well as sectors such as auto and property on concerns loan demand may slow.
The markets turned positive towards closing bell, the markets are likely to be choppy taking cues from global data.

January 28, 2010

January 04, 2010