RBI Monetary Policy- 31-07-2007

RBI monetary policy-
Focus on liquidity
Reserve Bank of India (RBI) delivered the first review of the monetary policy for the FY 2007-08 with a focus on liquidity management and status quo on interest rates.
Surging liquidity and the resultant steep fall in the money market rates prompted the RBI to raise the Cash reserve ratio and remove the cap of Rs 3000 crores imposed on the reserve repo amount under LAF.
The overall monetary policy stance continues to remain unchanged with a focus on price stability, re-emphasis on credit quality and orderly conditions in
financial markets. While the RBI in its policy acknowledged that non food credit growth has moved in the targeted range, the acceleration in money supply and reserve money may warrant an appropriate response.

Monetary measures

• Repo rate and reverse repo rate under the LAF has been kept unchanged at 7.75%
and 6.00% respectively
• The cash reserve ratio (CRR) of scheduled commercial banks (SCBs), is being
increased by 50 basis points to 7.00% with effect from 4th August 2007
• In view of the current macroeconomic and overall monetary and liquidity
conditions, it has been decided to withdraw the ceiling of Rs. 3,000 crores on
daily reverse repo under the LAF with effect from Monday, August 6, 2007


Impact on Debt market

􀀹 The increase in the CRR, will lead to an outflow of approximately Rs 15000
crores from the banking system.
􀀹 RBI’s measures is targeted towards balancing domestic liquidity and prevent a
liquidity related credit boom
􀀹 Yields on long term government bonds may continue to remain supportive on
account of status quo on interest rates and surplus liquidity. The 10-year
benchmark yield may trade in a broad range of 7.50%-8.00% till the next credit
policy review
􀀹 The short end of the curve will correct in view of the removal of the cap on the
reverse repo amount under LAF and the CRR hike. However, strong inflows in
the system on account of government spending and capital flow may cap any
sharp rise in the money market rates. Call rates are likely to stabilize between the
repo and reverse corridor
􀀹 Higher short term rates may encourage arbitrage related flows in the country
which may lead to further appreciation in the rupee.

Conclusion

The Reserve Bank will continue its policy of active management of liquidity through
appropriate use of CRR stipulations and open market operations (OMO) including the
MSS and LAF, thus exploring monetary instruments at its disposal flexibly, as and
when the situation warrants. Expectations of a surprise monetary tightening and
RBI’s bias towards tight liquidity conditions will prevent any kind of immediate
softening in interest rates. On the fund side we maintain our view for investors to
remain on the shorter end of the curve that is liquid fund, liquid plus fund and shortterm fund categories. Investors who have term money for 3 months, 6 months and 1
year can look at Fixed Maturity Plans for stable returns.

Rgds.,
Japan Shah