Turbulence in Indian Money Market – Call Rates Shoot Up

Monetary measures taken by Reserve Bank of India in the recent past in response to the huge credit growth and growing fears of inflation getting out of control, coupled with other seasonal factors like advance tax outflows, have led to a sever liquidity crunch in the Indian banking system. The cash squeeze led the call money rates to shoot up to as high as 20% this Friday.

This is much beyond the ceiling provided by the central bank’s repurchase window and something rarely since the monetary reforms began and the repurchase window was introduced as a mechanism to provide stability in the money market by providing a ‘corridor’ for overnight rates.

Bank credit has been growing at over 30% and the central bank is worried about the inflationary trends. As part of its continuing tightening policy, the RBI announced a two-phase hike in the Cash Reserve Ratio (CRR) earlier this month. CRR is the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank. The first phase kicked in on last Saturday (December 23) and the second phase will be effective from January 6.

Compared to an estimated surplus of about Rs 25,000-30,000 crore in the beginning of this month, there is a cash shortage of about Rs. 12-15000 crore now. The central bank injected an average of Rs. 12500 crore daily last week through its repurchase window, up from Rs. 4000 crore in the previous week. The repurchase window is expected to provide a ‘corridor’ for the overnight rates, with reverse repo rate and repo rate acting as the floor and the ceiling respectively. Reverse repo rate is the overnight rate at which the central bank sucks out excess liquidity by selling securities in the market and repo rate is the rate at which it injects liquidity into the system by buying securities.

The reason for the rates shooting up much beyond the repo rate of 7.25% is the decline in the bank’s holding of government bonds. With most of the banks’ holding being close to the minimum SLR requirement of 25%, they are not able to borrow from RBI under the repurchase window.

How long will the cash crunch last? It is expected to ease in the coming weeks, as coupon payments, government expenditure and special deposit scheme redemptions will bring back some cash into the system. These may bring the call rates closer to the repo rate of 7.25% - the informal ‘ceiling’ provided by the repurchase window. The days of easy money are, however, over. And, the banks should be ready for occasional bouts of volatility.

US jobs data beats forecasts,

Japan surprises on the negative side


The US economy beat forecasts by adding more jobs in November than expected, showing the economy's resilience as housing and manufacturing slump. According to the Labour Department report released on Friday, 132,000 jobs were added last month, a marked improvement from the 79,000 in October, and higher than market expectations of 110,000. The jobless rate rose to 4.5 percent from a five-year low of 4.4 percent.

The US economy expanded at a 2.2 percent annual rate in the third quarter - the slowest this year - largely owing to a slump in the housing sector and reports suggest that the weakness may be spreading beyond housing. Manufacturing, which accounts for about 12 percent of the economy, contracted for the first time in more than three years last month as inventories grew and orders slowed, according to the Institute for Supply Management report.

The jobs data is consistent with the soft-landing scenario and shows that the economic slowdown remains mild. The central bank has held its benchmark lending rate steady for a third straight month in October and is expected to maintain the stance at its forthcoming meeting next week. The Federal Reserve Chairman Ben S. Bernanke maintains that the economy will continue to expand and even pick up next year.

While the latest data release comes as a silver lining in the cloud of economic slowdown for the world’s largest economy, there were fresh clouds over the economic recovery of Japan. The world’s second largest economy has been emerging from a decade of stagnation, recession and deflation. According to the final numbers released by the Government, GDP in the July to September quarter was up 0.8% on a year ago, compared with the 2% estimated earlier. The main reason for the disappointing figures was a drop in domestic demand, which contracted by 0.2% from the previous three-month period.

The slower economic growth may prompt the Bank of Japan to delay interest rate increase which was expected to come as early as later this month. The Bank of Japan had raised interest rates from almost zero to 0.25% earlier this year in July, as the economy gained in strength and is expected to follow-up with more hikes in future.

Is OPEC ready for further cut?

Oil prices have risen in the recent weeks, amidst growing uncertainty and speculation on deeper production cuts from OPEC. The oil producers’ cartel which controls about 40 percent of the world's oil production is worried about a surplus of global crude-oil inventories and has been trying to stem the fall in prices after they fell from a peak of $78.40 a barrel in July to below $60 in October. According to latest estimates, the US has inventories of 340 million barrels, 14% more than average. Similarly, stocks held among the 30 OECD members stood at 2.76 billion barrels at September end, the highest level in almost eight years and 4.5 percent higher than a year ago.

The production cut of 1.2 million barrels a day agreed by the OPEC members in October has helped a rebound, although there were doubts about the actual cuts when the decision was announced. Crude prices have now come back to well above $60 a barrel.

And, now another cut is being contemplated by OPEC. OPEC President and Nigeria's oil minister Edmund Daukoru has been quoted as saying that he's “not comfortable” with current prices and is in favor of a further trimming in production. OPEC oil ministers are to meet next week in Nigeria. Will they deliver further cuts? While many members support deeper cuts, some believe that the current price levels are acceptable and can be maintained without further cuts.

Related post:

Of opaque flows, cuts and prices http://aktonmarkets.blogspot.com/2006/10/of-opaque-flows-cuts-and-prices-oil.html

RBI hikes cash reserve ratio to tame inflation

Reflecting the persistent worries on inflation amidst ferocious economic growth and surging forex inflows, the Reserve Bank of India has decided to raise the Cash Reserve Ratio (CRR) to 5.50 percent. CRR, a tool used by central banks to control liquidity in the system, refers to the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank.

Inflation, as measured by rise in wholesale price index, continues to stay near the higher end of the central bank’s target range of 5-5.50 per cent. The economy expanded 9.2 percent in the quarter ended September 30 and foreign investors have been pouring money into Indian stock markets, leading to an overwhelming liquidity surge. The current surplus liquidity in the banking system – reflected in the amounts absorbed by RBI in its daily reverse repo auctions (banks parking excess funds with RBI) – is estimated to be in the range of Rs 25,000-30,000 crore. This is on the back of a strong over 30% growth in bank lending.

“It is necessary to recognize the challenges emanating from capital flows and consequent impact on increasing liquidity”, the RBI statement notes. ``The overall impact on inflation expectations requires to be monitored and moderated.”

The CRR hike will be effected in two phases - from current 5 per cent to 5.25 per cent effective December 23 and to 5.50 per cent from January 6. The move will impound about Rs 13,500 crore of bank funds.

Related posts:

(1) 'Reddy' for another hike?

http://aktonmarkets.blogspot.com/2006/10/reddy-for-another-hike-when-reserve_28.html

(2) RBI hikes repo rate, leaves other rates unchanged

http://aktonmarkets.blogspot.com/2006/10/rbi-hikes-repo-rate-leaves-other-rates.html