In a clear move to rein in excess liquidity, the Reserve Bank of India (RBI) on Tuesday kept key rates unchanged but hiked banks? cash reserve ratio (CRR) by 50 basis points at 7% and removed the Rs 3,000-crore cap it had on daily reverse repos under its liquidity adjustment facility (LAF).

Both the operational rates?the repo and reverse repo?were kept unchanged at 7.75%, and 6%, respectively.

Unveiling the first quarter review of its Annual Monetary Policy for 2007-08, RBI governor YV Reddy said the measures were required to manage the excess liquidity in the system and keep inflation in check.

Inflation, measured by variations in the wholesale prices index (WPI) on a year-on-year basis, declined from 5.9% as of March 31 this year to 4.4% as of July 14. Prices of primary articles and manufactured products rose 10% and 4.6%, respectively, against the increase of 3.8% and 3.9% a year ago. The rising world oil prices were a concern ?but the domestic economic system cannot be ignored,? Reddy said.

As much as 95% investments in India come from domestic savings and the central bank?s prime focus is to bring about financial and inflation stabilities, the RBI governor told reporters after the policy review was announced. Trends in global output and their bearings on inflation was a concern though, he added.

The policy review underscored the stand that holding inflation within 5% in FY08 assumes priority in the policy hierarchy while reinforcing the medium-term objective to condition policy and perceptions to reduce inflation to 4-4.5% on a sustained basis.

There has been greater volatility in the money markets, including capital inflows and RBI has been reviewing the situation, Reddy said.

The hike in cash reserve ratio (CRR)to 7% effective this Friday will absorb surplus liquidity from the system to the tune of Rs 16,000 crore. Also, the removal of the reverse repo cap will drain out surplus cash from the market on a daily basis, Reddy said. Though banks do not get any interest on the CRR, Reddy opined that RBI does retain the option of paying interest provided the hikes were substantial. ?Nominal hikes (like 50 bps) don?t attract any interest,? he said.

The move on RBI?s reverse repo LAF will be effective from Monday. However, the cap could be re-imposed depending on the liquidity conditions. The second LAF would be discontinued from Monday.