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  1. 1. RBII POLIICY UPDATE R POL CY UPDATE Aug 1, 2007 RBI hikes CRR by 50bps For the second time in the current year, the RBI has hiked the cash reserve ratio (CRR) by 50bps to 7% effective from August 4. The RBI has clearly articulated its thrust on liquidity management in its monetary policy. There is excess liquidity to the tune of Rs 50,000- Rs 60,000 crore in the system and with current hike, about Rs 15,000 –Rs 16,000 crore will be sucked out. The RBI has maintained its other key rates like reverse repo, repo and bank rate steady. It has withdrawn the ceiling of Rs. 3,000 crore on daily reverse repo under the LAF with effect from August 6, 2007. Also, the second LAF session is withdrawn. GDP growth estimate is maintained at 8.5% for FY07-08. Non-food bank credit growth has moderated to 24.4% from 32% a year earlier with WPI inflation ranging between 4 – 4.5%. However, the appreciating rupee along with money supply growth at 21.6% continues to be a concern as it is much ahead of the RBI’s targeted zone of 17 –17.5% levels. Impact Banks: Currently banks have excess liquidity and a consequent fall in deposit rates has already started, but the decline in lending rates that was expected may be deferred on account of the hike. This may impact banks positively as deposit rates are falling, but lending rates are not, giving higher spreads. We don’t expect banks’ profitability to be much impacted due to the current move. Long-term prospects continue to remain robust for the banking sector though some pressure on funding costs may be seen in H2FY07, when credit off-take rises squeezing excess liquidity in banks. Bond Markets: The bond markets are expected to stay at current levels with slightly positive bias. We expect 10-year benchmark yields to move in the range of 7.8 – 7.9% but yields on the short end of the yield curve to move up in the near term. Call Money: We have seen excess liquidity in the system pushing call rates as low as a 0.2-0.5% too. With the current CRR hike and lifting of the LAF limit of Rs 3,000 crore, we believe call rates to come close to repo and reverse repo levels of 6 - 7% range giving some returns to banks on their excess funds. Our view The RBI continues to be hawkish on inflation front maintaining its stance of 5% for FY08 and 4 – 4.5% in medium term. Though inflation is in the range of 4 – 4.5%, the rise in crude prices and certain agricultural commodities globally too keeps RBI thinking on controlling inflation. The hike in CRR is the best short-term monetary tool to contain liquidity. We expect the current move to be an indicator of RBI’s move to actively participate in forex market buying dollars and contain rupee from strengthening further. We believe retail credit growth will taper down with interest rates continuing to remain high and bank stocks to remain stable in medium term after the immediate knee jerk reaction on announcement. Though the RBI’s move may appear negative in the near- term for banks, its objective is to ensure a monetary and interest rate environment that supports export and investment demand in the economy, along with liquidity management so as to enable continuation of the growth momentum. DISCLAIMER: The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Securities Limited (I-Sec). quot;The author of the report does not hold any investment/open position in any of the companies mentioned in this report. 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