The European Central Bank left interest rates unchanged today, shelving plans for an increase as the U.S. housing slump threatens to curb economic growth. Policy makers meeting in Frankfurt kept the benchmark refinancing rate at 4% but a survey shows that the bank may raise the rate to 4.25% in October.

The collapse of the U.S. subprime-mortgage market has made banks reluctant to lend, pushing up the cost of credit and causing turmoil on world financial markets. The ECB earlier today added 42.2 billion euros ($ 57.7 billion) in emergency cash to ease a credit drought that had pushed overnight deposit rates to a six-year high.

"The ECB finds itself in a dilemma," said Rainer Guntermann, an economist at Dresdner Kleinwort in Frankfurt. "Economic fundamentals require at least one more rate increase and inflation concerns haven't eased. On the other hand, it needs to deal with market turbulence." Trichet will hold a press conference at 2:30 p.m. in Frankfurt to explain today's decision. ECB President Jean-Claude Trichet on Aug. 27 retreated from a stance of "strong vigilance" on inflation, language he used to signal previous rate increases. Central banks worldwide are refraining from raising rates as they assess how the credit squeeze will affect economic growth.

The Bank of England today left its benchmark lending rate at 5.75%, and in Indonesia the central bank kept its key rate at 8.25%. The Australian and Canadian central banks also opted yesterday to keep borrowing costs unchanged. The Bank of Japan last month stepped back from plans to raise interest rates.

U.S. Federal Reserve chairman Ben S. Bernanke said on Aug. 31 that the bank will do what's needed to prevent the credit rout from undoing America's six-year economic expansion. Concern that defaults on U.S. home loans to people with poor credit histories would curb growth in the world's largest economy prompted a slide in stock and commodity markets and pushed up corporate borrowing costs in early August.

Central banks added more than $ 400 billion to money markets since Aug. 9 to ease lending between banks. Australia's central bank said today it will buy debt backed by home loans to add cash to the financial system. While those actions succeeded in reducing money-market rates for a time, by yesterday the overnight deposit rate for euros had climbed to 4.68%, the highest in six years. It fell to 4.10% after the ECB's injection today.

"The key question is now whether the ECB keeps its finger on the rate trigger, hoping conditions will return to normal quickly, or whether it thinks market volatility will spill over into the real economy," said James Nixon, an economist at Societe Generale SA in London. The ECB will publish new growth and inflation forecasts today, its first estimate of how the credit squeeze may affect the economy.

In June, the ECB predicted economic growth of about 2.6% in 2007 and 2.3% in 2008, and said inflation would average about 2% this year and next. The bank aims to keep inflation below 2%. In 2006, growth reached 2.7%, the most since the turn of the decade. Since then, Europe's economy has cooled. The expansion ebbed to 0.3% in the second quarter from 0.7% in the first. Manufacturing and service-industry growth slowed in August, and consumer and business confidence dropped more than economists forecast. German manufacturing orders dropped the most in at least 16 years in July, a government report showed today.

The Organization for Economic Cooperation and Development yesterday lowered its forecasts for U.S. and European economic growth and said they may be reduced further following the rout on financial markets. "Downside risks have become more ominous," Jean-Philippe Cotis, the OECD's chief economist, said in Paris. For now, "the euro-area economy is still growing at an above-potential rate," said Kenneth Broux, an economist at Lloyds TSB Bank Plc in London. "The current turbulence is a short-term issue, it's not going to derail economic expansion. Growth will re-accelerate in the third quarter." Klaus Baader, chief European economist at Merrill Lynch and Co. in London, said concerns that expensive credit will prevent companies from investing are misplaced.

The ECB has cited credit growth as an inflation risk. Loans to the private sector grew 10.9% in July from a year earlier, the bank said. M3 money-supply growth, which the ECB uses as a gauge of future inflation, accelerated to the fastest pace in 28 years. The bank is also concerned that economic growth will allow companies to pass on higher costs to consumers, boosting inflation. Oil prices have surged 51% since mid-January.

The Bank of England left the benchmark interest rate unchanged at a six-year high as it focused on curbing an increase in corporate borrowing costs that may crimp economic growth. The Monetary Policy Committee, led by Governor Mervyn King, kept the bank rate at 5.75%. The bank will release the minutes of the decision on Sept. 19.

"There are tentative signs of a slowing in consumer spending," the bank said in a statement that accompanied its decision. "But the recent solid pace of output growth has been sustained and the margin of spare capacity appears limited. Indicators of pricing pressure remain somewhat elevated. It is too soon to tell how far the disruption in financial markets will impair the availability of credit to companies and households."

The central bank yesterday took its first steps to reduce U.K. money-market rates, which have climbed to the highest since 1998, following the collapse of the U.S. subprime mortgage market. The turmoil has clouded the economic outlook less than a month after the bank signaled that five rate increases in the past year may not be enough to contain inflation. "They won't rush to raise rates, and they won't hurry to cut rates either," Geoffrey Dicks, chief U.K. economist at Royal Bank of Scotland Group Plc in London, said before the decision. "They're trying to work out where this turbulence leaves us." The bank said inflation may remain around, or a little below its 2% target for the next few months and that "pay pressures remain muted." Economic growth accelerated to 0.8% in the second quarter, up from 0.7% in the previous three months. Manufacturing expansion reached a three-year high last month and services growth unexpectedly quickened, surveys of purchasing managers showed this week. "Financial markets are becoming more of an issue for central banks right around the globe," said James Shugg, an economist at Westpac Banking Corp. in London. "Longer-term concerns about inflation haven't changed, but in the shorter term, there are downside risks to growth from the turmoil."

The Bank of England yesterday offered extra money next week to reduce "unusually high" overnight interest rates. The European Central Bank today loaned an additional 42.25 billion euros ($ 57.7 billion) to banks to help reduce the cost of credit. The shortage of funds in money markets is persisting even after the ECB, the Federal Reserve and other central banks added more than $ 400 billion to the financial system since Aug. 9.

The Australian central bank said today it will buy debt backed by home loans. Policy makers there and in Indonesia left key interest rates unchanged this week. The Bank of Canada made no change to its key rate, now 4.5%, yesterday. The ECB will probably keep its benchmark rate at 4% today, according to a survey of 56 economists. The U.S. Federal Reserve left its rate at 5.25% on Aug. 7.

Commercial banks have been reluctant to lend to each other because of concern about borrowers' vulnerability to securities backed by U.S. subprime mortgages, or home loans aimed at people with poor credit histories.

The gap between the U.K. benchmark rate and the three-month money-market rate, known as the London interbank offered rate, was the biggest in 20 years after yesterday's fixing. The rate was at 6.8%, compared with 6.03% on July 27. Policy makers said last month they had "no firm view on whether rates needed to rise further," while their forecasts released Aug. 8 suggested the key rate needs to reach 6% to get inflation to the 2% target in two years.

"Recent financial market developments are likely to have boosted the bank's willingness to monitor previous rate increases before making another move," said Lena Komileva, an economist at Tullet Prebon in London. "They're going to remain concerned about pipeline inflation pressures."

China ordered banks to put aside more money as reserves for a seventh time this year to cool the world's fastest-growing major economy after inflation surged to a 10-year high. Lenders must set aside 12.5% of deposits, starting Sept. 25, up from 12%, the People's Bank of China said today on its Web site.

China is trying to prevent cash from record trade surpluses fueling inflation, asset bubbles and overcapacity in manufacturing. The central bank raised interest rates for the fourth time this year on Aug. 22 after consumer prices climbed 5.6% in July as food costs soared. Money supply grew 18.5% in July from a year earlier. Each 0.5 percentage point increase in the reserve ratio drains about 186 billion yuan ($ 25 billion) from the banking system. Local-currency deposits stood at 37.1 trillion yuan at the end of July.

China's economy, the world's fourth largest, expanded 11.9% in the second quarter from a year earlier, the fastest pace in more than 12 years, on exports and investment. Government warnings that stocks may be overvalued haven't stopped the key CSI 300 Index from climbing 300% in the past year. Households invest money in shares and property instead of watching inflation erode the value of bank deposits.

In July, housing prices jumped 19.4% from a year earlier in Shenzhen and 10.4% in Beijing.

China's top priority is to prevent the economy from overheating and keep prices tamed, the central bank said in a quarterly monetary-policy report released Aug. 8. Consumer-price increases aren't solely the result of ``temporary factors,'' the People's Bank of China said then, highlighting energy and labor costs and people's expectations for inflation.

The benchmark one-year lending rate is at a nine-year high of 7.02% and the deposit rate is 3.6%. The central bank has also sold bills to soak up cash. The trade surplus surged 67% in July from a year earlier to .4 billion, the second-highest monthly total. China has resisted U.S. pressure to allow the yuan to strengthen faster, making exports more expensive and easing the inflow of cash. The currency has gained 9.8% versus the dollar since a revaluation in July 2005.

Instead, the nation has eased capital controls to let more money flow out. The government this year loosened restrictions on investment abroad by fund managers, brokers and banks and approved an agency to invest some of the nation's world-record $ 1.3 trillion of foreign exchange reserves.

U.S. Federal Reserve Chairman Ben Bernanke said that the central bank of US is prepared to take more actions to keep the credit crisis from hurting the economy. "The Federal Reserve stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets," Bernanke said at a Fed symposium in Jackson Hole, Wyoming. Though the chairman did not specify what the Fed's next move will be.

He said that It is not the responsibility of the Federal Reserve, nor would it be appropriate, to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.

In the light of the recent financial developments, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Fed continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets, he said.

Since Aug. 9, the Fed has injected a total of $ 147.25 billion into the financial system to ease tightening credit stemming from the troubles in the high-risk subprime mortgage market, which offers loans to people with lower credit and income. On Aug. 17, the Fed approved a half-percentage point cut in its discount rate on loans to banks to promote the restoration of orderly conditions in financial markets. The decision means the discount rate, the interest rate that the Fed charges to make direct loans to banks, has been lowered to 5.75% from 6.25%.

But the Fed did not change its target for the more important federal funds rate, the interest commercial banks charge each other on overnight loans. The benchmark interest rate has remained at 5.25% for more than a year. Many expect the Fed to cut its target rate by at least one-quarter percentage point on or before Sept. 18, its next regularly scheduled meeting. If so, that would be the Fed's first rate cut in over four years.

US President George Bush has outlined ways to help US homeowners facing foreclosure. It is the administration's first effort to deal with an expected wave of defaults fuelled by the mortgage crisis that has roiled financial markets around the world.

The initiatives, which are not aimed at bailing out lenders or speculators, are designed to help homeowners with risky mortgages keep their houses. In remarks at the White House, Bush also discussed efforts to prevent the problems from arising in the future. "The government's got a role to play, but it is limited," Bush said. "A federal bailout of lenders would only encourage a recurrence of the problem."

The President insisted that the US economy was strong and could weather recent turbulence in the financial markets. He said the mortgage market, especially the subprime sector, has shown particular strain. One of the most troubling developments has been an increase in adjustable-rate mortgages, which start out with low interest rates, then reset to higher rates after a few years.

"This has led some homeowners to take out loans larger than they could afford based on overly-optimistic assumptions about the future performance of the housing market," Bush said. "Others may have been confused by the terms of their loan, or misled by irresponsible lenders. Whatever the reason they chose this kind of mortgage, some borrowers are now unable to make their monthly payments, or facing foreclosure."

One of the key elements of Bush's plan would allow homeowners with a good credit history, but who cannot afford their mortgage payments, to refinance into mortgages insured by the Federal Housing Administration to stop them from defaulting. Earlier this month, Bush predicted that the continuing decline in the housing market would not become precipitous, but would result in a "soft landing".

He rejected any direct government aid to homeowners losing their houses to foreclosures, saying he only supported federal government help that would encourage refinancing and educate prospective home buyers about risky mortgage terms. Bush urged Congress to pass legislation that would give the Federal Housing Administration more flexibility in assisting mortgage holders with subprime mortgages. He pledged to work with Congress to reform the tax code to help troubled borrowers rework their loans and called for the rigorous enforcement of predatory lending laws and strengthening of lending practices.

Any relief due to a possible reduction in the interest rates is out for the consumer. Last week, the Reserve Bank of India's (RBI) credit policy kept the reverse repo and repo rates untouched while increasing the cash reserve ratio (CRR) by 50 basis points.

"This is aimed at correcting the aberration of surplus liquidity," says Abheek Barua, chief economist, HDFC Bank. The result: a reduction in the deposit rates while the lending rates stay static for the time being so that banks do not face a pressure on their net interest income. As far as numbers go, the deposits rates are likely to come down to about 8.5-9 per cent as against the current rates of 9.5 per cent on one-year deposits.

Meanwhile, Finance Minister P Chidambaram, had also goaded banks to reduce deposit rates as he wants lending rates to be brought down to help sectors like auto and real estate so that the growth rates are not impacted. But this seems unlikely in the short term, according to banking industry observers. Says A Prasanna, vice-president, ICICI Securities, “Lending rates will continue to remain stable in the short term.”

“Certain interest-sensitive sectors like automobiles and real estate, where large value deals require the consumer to borrow, would be adversely affected,” points out Indranil Pan, chief economist, Kotak Securities. This would be keeping in line with RBI governor Reddy's plan to slow down the excesses in retail lending including loans for homes, cars and consumer durables.

Going forward, on the interest rate front, one can expect the market to stay tight for the next three months. Of course, when the buying season starts in the month of October, there are fears that the inflation which has been brought some control (at 4.4 per cent) could go up because of credit offtake. This could invite another hike from the apex bank to rein in inflationary pressure.

Experts are of the opinion that another 50 basis points cannot be ruled out. As the G-sec chart shows, interest rates have been on the rise.This would typically mean that for potential home buyers or car buyers, the costs could get higher in the months to come.

The only saving grace could be come, if the prices of assets like land start correcting themselves. This would provide much relief for the home buyer.

With the Reserve Bank of India Governor YV Reddy announcing a 50 basis points increase in bank cash reserve ratios to 7% (amount of depositors money that the commercial banks have to park with the RBI), the reaction was immediately felt by the common people—banks have reduced the interest rates they were offering on 1-year fixed deposits from as high as 10% to single digits—government sees it being reduced to as low as 8.5%.

State owned banks were first out of the blocks with Bank of India and Bank of Baroda announcing a reduction in the deposit rates by 0.5 per cent to 9 per cent. Earlier, Allahabad Bank, Indian Bank and Punjab Bank had reduced rates on deposits too.

The banks will now have to maintain their cash reserve ratio (CRR) at 7% with RBI since it is mandatory for them to do so. But, the short-term deposit levels for the common people is no longer as lucrative as it was in the few preceding month and will lead them to look again in investing in mutual funds—many investors had taken their money out of mutual funds and put it in fixed deposits with banks as the interest rates were very high in two digits and there was a virtual guarantee of getting it, while in MFs there was no guarantee of profit.

Deposit rates are likely to be reduced but lending rates may not change soon. Finance minister P Chidambaram on Wednesday asked state-owned banks to reduce one-year deposit rates to 8.5% from the current levels of 9.5% and above.

Further, he suggested that banks could pass on the benefit of reduced deposit rates to the borrowers by keeping lending rates steady, but bankers ET spoke to ruled out softer lending rates for now. He said that the 50 basis points hike in the cash reserve ratio (CRR) will not impact the 24% credit growth this year.

"Banks may lower deposit rates of one year maturity by 0.5%. Some banks have already done that and interest rates will come down to 8.5%. My impression is that it will stabilise at that level," Mr Chidambaram said after his meeting with CEOs of state-owned banks. Bankers on their part feel that deposit rates are likely to fall lower than 7.5%.

"Banks have assured me that credit needs of the productive sectors will be met. Individual banks have to take a call on lending rates. In any case I am told many customers borrow at rates below BPLR (benchmark prime lending rate). The hike in CRR will not have any serious impact on the 24% credit growth for this year," he said. Banks have carried out substantial rebalancing of portfolios, he added.

Bankers are of the view, that there is no case for reducing rates for borrowers, because liquidity is going to be tight once the busy season kick-starts in three months time. "The short term interest rates may not harden, but medium to long-term rates will not be soft, once the busy season kicks in. It therefore does not warrant a reduction in lending rates" a banker said.

Banks feel that the hike in CRR will not have much impact and said that there would still be surplus liquidity in the system. "Though deposit rates will come down, it cannot translate into a reduction in lending rates. We have to keep our NIMs in mind," a banker said.

The FM conceded that liquidity tightening by RBI is expected to hit banks' net interest margin. However, the currently healthy balance-sheets of banks will help cushion the impact on the bottomline. He said RBI's concerns on liquidity is legitimate.

"The RBI has used two instruments, one obligatory -- the CRR hike -- and the other is the window for banks -- raising the cap on reverse repo.
The net impact of these measures will hit the NIM of banks' marginally, but they have healthy balance-sheets and can cushion the impact." Draining Rs 16,000 crore on the system on account of CRR is estimated to have a 0.03% impact on the net interest margin of banks, he added.

"There was unpredictability as far as interest rates were concerned. A significant amount of loans have been sanctioned, but not disbursed, because borrowers were anticipating a softer bias on lending rates.

That has now been ruled out," Mr SK Bhattacharya, managing director, State Bank of Bikaner and Jaipur. "No bank will pay 8.5% on deposits, when banks can park their funds at 6% at the reverse repo window," he added.

"The benchmark yield of 364 day T-bill has come down by 140 basis points. This is an underlying indicator for deposit rates. So consequently, deposit rates must soften too, else there will be a widening in the yields," Canara Bank chairman MBN Rao said.

The 9.5% yield on one-year deposit was a blip. It is higher than the yield on 10-year government paper. He added that the increase in lending rates were gradual, however deposit rates grew too fast in the last quarter of 2006-07.

In his meeting, the FM also asked banks to step up lending to minorities from 9% of total priority sector advances to 15% over the next three years. The government has identified 121 such districts.

Some of the banks have tripled their credit flows in the past few years. With the overall size of the portfolio going up, the quantum of NPAs in absolute terms are increasing as well. But bankers are not worried, because in proportionate terms, NPAs are only 2% of the total portfolio.

The Finance Minister, P. Chidambaram said that there has been a sharp increase in priority sector advances of PSU banks. The SME credit has totalled Rs 184589 crore registering an increase of 25.81% YoY, he added.

The RBI is concerned with liquidity, Chidambaram said. By increasing the CRR, the RBI has sucked out Rs 15000 crore of liquidity from system, he said, adding that the concerns are valid.

He informed that there has been a net impact of the CRR hike & Reverse repo window opening; the net impact on NIMs would be 0.03% . The PSU bank balance sheets are healthy and will absorb this small hit, Chidambaram said. He said that banks are inclined to lower their deposit rates on 1-year term deposits by about 50 bps. Already some banks have lowere 1 yr deposit rates to 8.5% from 9%.

He maintains that there would be no serious impact of the new monetary policy announcement. He projects the credit growth at 24% in FY08.

Yesterday, the RBI announced a hike in banks' cash reserve ratio by 50 bps to 7% in an effort to slow money supply expansion and as a signal for banks not to slash lending rates as monetary policy remains tight. But the central bank kept the repo, reverse repo and bank rates unchanged.

A higher priority for managing "appropriate" liquidity conditions in the policy hierarchy has been accorded at the current juncture, the RBI said in its first quarterly review of the 2007-08 (Apr-Mar) Annual Policy.

Worried about the acceleration in money supply and reserve money--which are threats to inflation--the RBI said banks will have to keep aside 7% of their demand and time liabilities, or an additional 150 bln rupees, from Aug 4 as cash reserves. Including today's hike, the RBI has raised the CRR by 200 bps since December. The RBI also said it was lifting the 30-bln-rupee cap on reverse repo bids, from Aug 6, it accepts to drive up overnight rates, and to provide an alternative to banks to deploy overnight funds relatively more remuneratively.

The RBI, however, warned that it may re-impose the ceiling on the reverse repo bids it accepts if monetary conditions warrant. The RBI also scrapped the second repo and reverse repo tenders it conducts every day under its liquidity adjustment facility from Aug 6. The central bank will continue to actively manage liquidity through CRR, Market Stabilisation Scheme and LAF, using all the instruments, as and when the situation warrants, RBI said in its review.

CRR HIKE IMPACT
Government bond yields rose and share prices, especially banking ones, fell sharply as the hike in CRR took some market players by surprise. Earlier, expectations were that the RBI may not resort to any extreme
monetary tightening step because inflation was under control and banks' credit growth had decelerated. "It is more hawkish policy than what was expected. From September, call rates will move to 7.75-8.00% and stay at these levels for six-to-eight months. RBI will have to keep tightening policy for controlling inflation,"
Shailendra Jhingan, debt fund manager, HSBC Mutual Fund said. Jhingan expects another 50 bps hike in CRR by Oct-Nov.

Banking shares rose and bond yields fell in the run up to the policy review. The RBI is worried that growth in money supply and reserve money was above estimates. As on Jul 6, year on year growth in money supply, or M3, at 21.6% was way above the RBI's target of 17.0-17.5%. Reserve money expanded 29.1% on year, up from 17.2% a year earlier. "The central bank sees inflationary pressure from liquidity and high growth in credit," said Kotak Mahindra Bank Chief Economist Indranil Pan. "With the demand pressure high in the economy, the monetary stance continues to be tight."

"The central bank does not want excess liquidity in the system," said YES Bank Chief Economist Shubhada Rao. The CRR hike is not expected to tighten liquidity significantly, bankers said. The step only modulates the availability of funds. "I do not see banks raising lending rates due to the CRR hike. In a period where credit growth appears to be declining, raising lending rates is not an option banks will look at," Rao of YES Bank said. Some banks even appeared defiant to the hike in CRR, and said lending rates are bound to come down.

"The CRR hike will not stop interest rates from coming down. Deposit rates have already started coming down, lending rates will also fall. The current interest rates are at unusual level, so they should come down," said
IDBI Chairman Yogesh Agarwal.

TAKE AND GIVE
While raising the banks' cash reserves, the RBI has also ensured that banks get compensated more for their surplus liquidity. The RBI removed the 30-bln-rupee ceiling on reverse repo tenders. This means that the RBI will pay 6% for a greater amount bids at its tenders. The RBI pays no interest for the CRR maintained by banks. The RBI also scrapped second set of repo and reverse repo tenders.

"This was required. It was creating artificial liquidity and artificially lowered overnight rates to 0.50%," said Jayesh Mehta, managing director and head of debt markets, DSP Merrill Lynch. The removal of the reverse repo cap meant that the corridor for overnight rates will be restored between 6.0-7.75%. "The sanctity of the LAF corridor is reinstated, which lost its relevance after the overnight rates fell to near-zero levels in the last one month," said a bond dealer.

"The move also means that focus is back on active liquidity management," another dealer said. Liquidity has surged due to the RBI's dollar purchases, government's cash balances, rising bank deposits and foreign credit.

INFLATION OUTLOOK
Monetary management would need to be watchful of movements in commodity prices, particularly oil prices, and elevated levels of asset prices, the RBI said. "The re-emergence of pricing power among producers is a potential threat to inflation expectations," it added. "While the central bank has said headline inflation has turned benign, it would definitely monitor pressures on inflation from higher crude oil prices and demand side pressures," YES Bank's Rao said.

Risks to inflation outlook persist owing to rising crude and food prices in global markets, the RBI said retaining its inflation target for 2007-08 to within 5% and 4.0-4.5% in the medium term. "It is necessary to continuously assess the risks to the inflation outlook emanating from high and volatile international crude prices, the continuing firmness in key food prices and the uncertainties surrounding the evolution of demand-supply gaps globally as well as in India," the RBI said in the statement.

Crude prices are hovering close to their record highs of $ 78.40 a barrel leading to fears of a hike in domestic fuel prices leading to rise in inflation and in turn interest rates. "Domestic prices of petrol and diesel, have undergone two downward revisions during 2006-07. It is necessary to recognise the need for some more pass-through from recent movements in international crude prices," the RBI said.

Currently, the headline inflation, based on Wholesale Price Index, is at 4.41% compared with 4.27% a week ago. The rise in inflation was mainly due to increase in primary article prices. Demand pressures appear to be stronger than before, while uncertainty over supply has increased due to rising crude prices, the RBI said. There are concerns over sustainability of high growth, the RBI said, even as it retained its forecast for GDP growth in 2007-08 at 8.5%. In view of the perceived threat from rising commodity prices and volatile financial markets, the RBI urged banks and corporates to mitigate risks and adopt prudent currency and interest rate strategies.

Other highlights:

RBI Policy: Removes Rs 3000 crore reverse repo cap from Aug 6
RBI Policy: Keeping inflation within 5% FY08 assumes priority
RBI policy reiterates 4-4.5% medium-term inflation aim
RBI Policy: Monetary stance spelt out in Apr retained
RBI Policy: Headline inflation has turned benign
RBI Policy: No second reverse repo, repo auctions from Aug 6
RBI Policy: Outlook for FY08 inflation remains unchanged
RBI Policy: Higher priority for managing "appropriate" liquidity
RBI Policy: Banks, cos must ensure currency, rate hedging plans
RBI Policy: Hedge funds pose significant risks to mkts
RBI Policy: Need to be watchful of commodity, oil prices
RBI Policy: Prospects for FY08 GDP growth appear positive
RBI Policy: Inflation pressures seen from liquidity, high credit
RBI Policy: Net capital inflows very strong so far FY08
RBI Policy: Crude, food prices rise risks to inflation outlook
RBI Policy: Risks to inflation expectation up on high oil prices
RBI Policy on inflation: Need to be watchful of high asset prices
RBI Policy: Domestic outlook continues to be favourable
RBI Policy: Liquidity gets higher priority in policy hierarchy
RBI Policy: Pvt equity funds' size risk to emerging mkt economies
RBI Policy: M3, reserve money rise warrants appropriate response
RBI:Inflation threat from re-emergence of producers' price power

Reacting to the policy, Ajay Mahajan, of Yes Bank said that he is expecting the bond market to rally significantly. He said that it was not expected from RBI to remove the reverse repo cap. Abheek Baruah, Chief Economist, HDFC Bank said that 91-day T-Bills may go up by 150 bps.

Nilesh Shah of ICICI Pru said that FMP products are likely to see increased action. He further said that the RBI seems to indicate that it may take swift actions to maintain growth momentum and manage inflation. Interest rates are unlikely to harden from current levels.

MBN Rao, Chairman, Canara Bank said that pressure on interest rates on deposits and lending rates may ease and the bank may cut deposit rates due to rate hikes by RBI. The lending rates may remain constant for some time.

Its that time of the year again - when bankers and bond dealers queue up to hear Reserve Bank governor, Y V Reddy announce the review of the monetary and credit policy. Will rates go up or down? CNBC TV18 polled the banking community to find out.

The central bank has aggressively tightened monetary policy since late 2004 to halt inflation led by robust industrial expansion and steep gains in global crude prices for a nation that imports about 75% of its petroleum needs. Analysts say that while price pressures remain in India's economy, the cumulative tightening of the past few years has slowed down spending by dampening credit growth.

It's a roulette policy say bankers who are wary of outguessing the RBI governor Y V Reddy. Yet this time around they point out that Reddy cannot hike rates, since the repo and the reverse rates have been practically held in abeyance by the RBI since June. However, 63% of the bankers polled say that the RBI may hike the Cash Reserve Ratio by half a percentage point to 6.5%. so as to reduce the excess liqudity. Yet bankers say this CRR hike will only effect a mild and temporary fall in bonds, while rates in the real economy continue to soften.

Also flush liquidity, apart from softening short-term money market rates, poses inflationary risks and also threatens to push credit growth back towards the peak of around 30% witnessed in the previous three years.
The liquidity has been largely on account of the RBI’s purchases of dollars from the market to check the rupee’s sharp rise. Though foreign fund inflows into equities have remained strong, overseas borrowings and foreign direct investment have equally contributed to a glut in inflows.

The rupee has appreciated by over 8.2% since March 31, 2007, severely denting the competitiveness of exports, which account for nearly 20% of the country’s GDP. The RBI’s need to sterilise liquidity infusions following its interventions in the foreign exchange market to stem the rupee’s sharp rise would have to entail measures for liquidity absorption. Analysts said the central bank’s inaction for a relatively long period, which caused the overnight call rates to remain closer to zero per cent, has sent confusing signals to the market. The call money rate closed at 0.2% today.

This time around bankers are more focussed on the reverse repo, the rate at which the RBI absorbs money from the banking system. Since March, RBI has only been absorbing Rs 3000 crore a day and this has led to money market rates crashing. Dealers say RBI may up this cap to say Rs 10,000 crores, some even believe the additional Rs 7,000 crores may be absorbed at a lower rate, making it a 2 tier reverse repo. However none believe the cap will be removed altogether.

India's economy grew by 9.4% in the last financial year and the central bank has forecast growth to slow to 8.5% this year. Analysts also said leaving rates on hold could act as a signal to commercial banks to start reducing lending rates. Bankers say even if the CRR is hiked or the reverse repo cap is raised, ample cash will remain in the system, forcing bankers to bring down rates. Only if both the CRR and reverse repo are tightened, rates are likely to remain where they are. So for the small borrower there may be good news after the policy.

Cholamandalam - CREDIT POLICY, Gateway Dist, ALMONDZ TRENDZ - Technical daily, ASK RJ - Hexaware


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The Reserve Bank of India, or RBI announced its annual credit policy on Tuesday. It has kept all the policy rates - the CRR, repo as well as the reverse repo rates unchanged.

The apex bank's move did not surprise the markets. It left all key policy rates unchanged and maintained a status quo on its monetary policy stance.

Ajay Shah, Economist with IGIDR, comes back with the opinion that it is a given that monetary policy works with a lag. If however the latest available data on inflation is showing that inflation is roughly at 7.5% and if the two policy rates are at 6% and 7.5%, then the two real rates would be 0% and minus 1.5%.

He doesn't think this stance of monetary policy will slow down inflation. There is usually, a long lag between real rates slowing down the business cycle, which he doesn't see happening at this point. The story is far from over and there may be problems in store on inflation.

The first reaction from the markets has been one of relief. On whether this keeps the door open for an inter-policy rate-hike, Samiran Chakrabarty, Economist wih ICICI Bank, believes that the RBI seems to be much less hawkish than what it has been talking in the last few policies.

He welcomes the step that the RBI is recognizing the lagged impact of policy responses and that augurs well for the growth outlook. But eyes need to be kept open towards the inflation outlook and watch how it pans out. That will be the clue to an intermitting rate hike.

Could there be a reason for inflation to fly off the handle, simply because rates have not been hiked? On this Ajay Shah is of the opinion that he doesn't want to overplay the argument, as there cannot be a real rate of, roughly, zero. Secondly, there are the CRR hikes and exchange rate appreciation, which will benefit the inflationary data. There is also a non-transparent piece of monetary policy, which is, how the RBI trades on the currency markets.

Becasue, how they trade on the currency market affects local interest rates. It is a non-transparent tool of monetary policy, which can be used in coming days.

He says one does not really know how things are going to pan out, and that the situation is genuinely worrisome. He does not share the comfort of other people who seem to think that inflation is tolerable and low interest rates should sustain growth; that is a false perspective, because there is no trade-off between inflation and growth. The inflationary spiral will fundamentally contaminate growth.

While, Samiran Chakrabarty thinks that the policy has kept everyone guessing. If that is the case, then inflation-fighting seems to be the predominant stance and policy response, going forward, is likely to have a tightening bias. It's difficult to quantify the number of rate hikes expected at this point, but inflation target being reduced a tiny bit to 5% is worrisome.

So, it has to come to below 5% for RBI to become comfortable on the inflation front. That has still some way to go, he thinks.