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The Reserve Bank of India (RBI) in its first quarterly review of monetary policy for 2007-08 hiked the Cash Reserve Ratio (CRR) by 50 bps to 7% from 6.5% but left other benchmark interest rates unchanged. With inflation hovering with in its medium term target of 4.0-4.5%,
the RBI pressed the pause button on any hike in key rates, barring the hike in CRR by 0.5% to suck out excess liquidity from the system.

By the hike in CRR, the amount of depositors money commercial banks need to park with the RBI got increased. This will make a dip in banks' deposit interest rate. The exact quantum of dip in deposit interest rates is dependent on the Assets and Liability maturity pattern of the individual banks. Only Asset Liability Committee (ALCO) of individual banks can take decision on the same.

The central bank, in its quarterly review of monetary policy today, also removed the Rs. 3000 Crore cap on daily reverse repo transactions, the window through which it absorbs liquidity in a bid to check volatility in call money rates. This is seen as another move by RBI to absorb the excess liquidity from the market. This will also help to increase the call money rates, which is right now as low as Zero percent. Absorbing of liquidity will have wide ranging impact on the banks, they will be left with lower funds available for disbursal to borrowers. The impact of CRR hike is not direct on the lending rates and no bank is in a mood to reduce its Prime Lending Rate (PLR). Hence, the banks' margins are likely to come under pressure.

CRR hike will effect the credit growth where there is already a visible deterioration. With this increase in CRR limits plus the fact that corporate can now access funds from overseas, there is strong possibility of a slowdown in credit growth, which may not be the intention of RBI to achieve targeted GDP growth rate.

The RBI will endeavour to contain inflation close to 5% in 2007-08, and to the range of 4.0-4.5% over the medium term. The hike in CRR increases the expectations for an immediate fall in interest rates in view of easy liquidity position and low inflation.

The RBI, for policy purposes, has retained the real GDP growth expectation at 8.5% "barring domestic or external shocks". The GDP growth at 8.5% with the inflation targets at 5% reflected the fact that the major correction with reference to inflation management is over. This credit policy may not do much to ease inflationary pressure as there is an added pressure from crude oil pricing and worldwide demand. However, RBI called for watching over commodity prices, particularly oil and the elevated levels of asset prices and the re-emergence of pricing power among producers. It said that these needed to be watched as potential threats to inflation expectation.

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Dr. Gourav Vallabh is at present Professor (Finance) at XLRI Jamshedpur.
He is a Certified Financial Risk Manager (GARP, USA), Chartered Accountant (ICAI, India), Company Secretary (ICSI, India), Ph.D. (UoR, India), M.Com., LL.B.
Currently, he is also associated with Govt. of Rajasthan in the capacity of Honorary Advisor to Ministry of Revenue.