The Hindu Business Line : CRR hikes could be reversed

The rate decisions of the Reserve Bank of India (RBI) and the Federal Reserve dominated last week. The Indian central bank did not change its repo and reverse repo benchmarks, but increased the CRR to 7.5 per cent from 7 per cent, while the Fed snipped its rates 25 basis points.

The CRR hike will take out about Rs15000 cr. of liquidity without cost to the Government or the RBI. The burden of servicing the MSS (sterilisation) bonds and reverse repo funds to drain liquidity was clearly becoming unsustainable.

Overnight money market surpluses have dwindled to less than Rs10,000 crore. Coupling the impounded CRR and the reluctance of the Government to spend ahead of the financial year close, it would seem liquidity is set to tighten in the coming days and weeks. Short-term yields, in particular, could see a significant rise.

Inflation is still down; in fact it fell to 3.02 per cent last week. But, as the RBI Governor says, it is partly suppressed because domestic energy prices have not been adjusted to reflect soaring global crude prices.

The other risk factor is the worsening budgetary position of Government, which could be compounded by the Pay Commission’s awards.

The stock market’s strength clearly strikes a discordant note amidst these negatives.

Not hunky-dory

It as not as if it is hunky-dory in the US. Heads rolled in two major financial institutions, Merrill Lynch and Citicorp, following huge write-offs.

There is still no light at the end of the tunnel as far as the sub-prime and CDO portfolios of banks and special investment vehicles are concerned.

Meanwhile consumer and business confidence numbers are sliding. Housing, it need hardly be said, is staying in doldrum territory.

Friday’s unexpectedly strong jobs report may be just a flash in the pan. Significantly, bonds rose after the payroll data. 10-year yields dropped to 4.3 per cent levels and shorts are well below 4 per cent.

The Fed’s post-meeting statement thought inflation remains a threat but it could be posturing at a time when rates have to be cut. There is every possibility of the US economy sinking into the red this quarter itself. Further rate cuts are unavoidable.

That might halt the RBI on its tracks. Reversing the series of CRR hikes, at least partly, is distinctly likely if liquidity contracts too much and call rates spill well out of the RBI’s corridor on the upside.

A lot also depends on whether capital flows will continue in an environment of global risk aversion. That will buttress the case for a CRR cut, perhaps in the first quarter of 2008.

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