Expect rates to move up during the year

Given inflationary pressures and the economys growth momentum,economists expect interest rates to rise further....

What did the RBI do in its credit and monetary policy?

The Reserve Bank of India RBI hiked the cash reserve ratio CRR of banks to 5.75 per cent from 5 per cent,but left the repo and reverse repo rates unchanged at 4.75 per cent and 3.25 per cent respectively. This was higher than the markets expectations of a 50 basis points bps hike in the CRR. The CRR hike will be implemented in two stages a 50 bps increase on February 13 and a 25 bps increase on February 27.

What impact is this move expected to have?

This move will sequester about Rs 360 billion from the banking system,which is about half of the excess funds that banks are parking in the reverse repo window.

Why did the central bank raise the CRR rate?

The RBI has begun the rate-tightening cycle on account of runaway inflationary expectations and its assessment of strong growth momentum within the economy. In its policy announcement,the RBI raised both its inflation and growth forecasts. Its end-March WPI inflation target was raised from 6.5 per cent earlier to 8.5 per cent. GDP growth forecast for FY10 was raised from 6 per cent earlier to 7.5 per cent now.

What does this mean for you?

Economists dont think that banks will raise rates immediately. Says economist Tushar Poddar of Goldman Sachs: Given the long transmission lags,we do not think the move will translate into changes in bank rates in the first half of 2010,and therefore there will be no near-term significant change in borrowing costs.

The rupee could strengthen because of hiking of rates. Higher rates,stronger growth and potential reforms point towards the rupee strengthening against the US dollar. Our three,six and 12-month dollar-to-rupee targets are at 44,43.4,and 43 respectively, says Poddar.

As for the stock markets,Raamdeo Agrawal,director and co-founder,Motilal Oswal Financial Services says: We are going to see corporate earnings boom in the next 12-14 months. The next big development will be the budget. If the budget leads to a 5-10 per cent correction in the market,that will be a brilliant opportunity to pick up stocks.

What does the future hold?

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Poddar expects a higher-than-consensus 300 bps of effective policy rate increases in 2010 150 bps coming from outright rate hikes and 150 bps from rates moving from the reverse repo to the repo window. Rohini Malkani,economist at Citigroup,expects policy rates to be raised by 125 bps this year and CRR by 50-100 bps. Economists feel rates could be hiked again at or before the next policy meeting that will take place in April.