The financial sector regulators moved in tandem on Monday to restore investor confidence in the Indian markets. The watchdogs responded with urgency as the benchmark Sensex of the Bombay Stock Exchange tanked by 724.62 points to a two-year low on overseas investors pulling out funds to meet liquidity crises in the US and European markets. The pullout made the rupee fall to a five-year low against the dollar, which in turn made banks borrow a record Rs 90,725 crore from the RBI to meet their liquidity needs.
RBI responded with a 50-basis points cut in the cash reserve ratio to pump in an additional Rs 20,000 crore to banks, while the Securities and Exchange Board of India relaxed the curbs on participatory notes to make it easy for foreign investors to take positions in the domestic equity markets.
The good news is that global commodity prices have dipped to their lowest since 2001 with crude prices going below at $90 a barrel on Monday. Palm oil importers are renegotiating contracts as futures prices have dipped sharply. This means inflation concerns are rapidly fading. Inflation has eased below 12% and further easing is on the cards. The CRR cut is the first policy action by the new RBI governor D Subbarao after taking over in September.
Analysts say the CRR cut would lower short-term interest rates, although FIIs will take time to raise their equity exposures despite the relaxation in participatory note norms. The opening market on Tuesday will show if the twin steps have made an impact.
CRR cut by 50 bps, first in five years
To reverse the tight liquidity situation in the domestic markets brought on by the global financial turmoil, the Reserve Bank of India on Monday reduced the cash reserve ratio (CRR)?the amount of reserves banks keep with RBI–by 50 basis points, the first time in five years. It also made it clear that liquidity concerns, not inflation, will get priority now.
The new CRR of 8.5% in place of 9% will come into effect from October 11. Since September 16, when the global crisis broke, the daily borrowing by banks through the repo window has jumped from an average of Rs 15,000 crore to above Rs 50,000 crore. On Friday, October 3, RBI data shows bank had borrowed Rs 90,725 crore from the central bank. As on Monday, in the very first auction, the banks have borrowed Rs 49,460 crore at an interest rate of 9%. The bank said the CRR reduction will release Rs 20,000 crore into the system.
The central bank had raised CRR by 400 basis points since December 2006 to check inflation, with the last revision occurring in July this year with a 25-basis point hike. Explaining its stance, RBI governor D Subbarao said, ?In view of the evolving environment of heightened uncertainty, volatility in global markets and the dangers of potential spillovers to domestic equity and currency markets, liquidity management will continue to receive priority in the hierarchy of policy objectives over the period ahead.? The central bank has already raised interest rates on NRI deposist by 50 basis points in September.
It also gave banks leeway to use 1% of their SLR rquirement for obtaining liquidity from the the RBI?s liqudity adjustment facility.
The banking industry said the step was timely and will cool the call rates hovering around 15%. NS Venkatesh, MD & CEO of IDBI Gilts, said, ?This cut in the cash reserve ratio came as a complete surprise to us, as we just did not expect this to happen. This move by the central bank is mainly to bring in liquidity into the banking system, which is currently tight. With this move, we expect call rates and bond yields to soften now. We can see call rates touching 10-10.50% levels by this week and to 8.50-9% by next week. Bond yields too will slide to touch 7.85-90% levels this week, before the auctions. It can also go to touch 7.75% soon.?
For a cut in interest rates, the key lookout will be the inflation rate. RBI will take a call only if the rate eases appreciably below 12%. It is currently just lower than that, while the RBI target is 7% for 2008-09.
RBI said Monday?s measure was ?ad hoc, temporary in nature and will be reviewed on a continuous basis in the light of the evolving liquidity conditions.?
