CRR Hike Unlikely Now, No Lower Rates Either

By increasing the market stabilisation scheme (MSS) ceiling by Rs 50,000 crore, the Reserve Bank of India (RBI) can jolly well tell the currency market to lay off.

More importantly, it also means that it’s unlikely to go for a 50-100 basis points hike in the cash reserve ratio (CRR) any time soon.

There are three reasons for this. First, with the MSS limit nearly exhausted (bonds worth Rs 1,45,000 crore out of the Rs 1,50,000 crore permitted were issued already), the RBI had no weapon to counter the rupee liquidity it generated by intervening in the forex market. The new MSS bonds will do the job now.

Secondly, the government’s borrowing schedule is very heavy in October, November and December, which will absorb substantial money market liquidity.

Thirdly, portfolio inflows tend to taper as stock market valuations hit the higher ranges, notwithstanding the currency arbitrage. For who’d want to bet on diminishing returns?

All of these give the RBI significant elbow room. Governor Y V Reddy will be forced to hike CRR only if dollar inflows remain torrential for an extended period of time from hereon.

The hike in the MSS ceiling also shows the RBI does not want interest rates to come down anytime soon because, after a long gap, inflation will start to rise once again this month as the high-base effect starts wearing off.

Lowering the interest rate will only aggravate the inflation problem looming.

The central bank would actually love to raise interest rates but it can’t because such a move brings in carry-trade or arbitrage money (such as NRIs parking their funds in India to benefit from higher interest rate), which sets off another liquidity-gush cycle.

Since the money market was expecting the ceiling hike, bond yields have already risen. Add to this the more than Rs 50,000 crore of surplus liquidity in the banking system, and yields are unlikely to fly on Friday - bets are on just 5 to 10 paise movements. The yield curve remains how it is.

On the fiscal side, there is additional cost involved because the government will have to pay interest on all the new MSS bonds issued.

Also, intervening in the forex markets to stem the dollar tide has another cost: the RBI is buying a currency that’s going only one way - down.

So, the value of all the dollars it buys to defend the rupee will only depreciate.

In 2007 so far, the RBI has bought $38 billion worth of dollars, and the dollar has depreciated 11 per cent against the rupee. The loss thus runs into thousands of crores.