Of froth and bubbles
.…. and fundamentals

In 2003, the Bombay Stock Exchange's Sensex index passed what was seen as the psychologically crucial 4,000 mark. It closed Thursday at 14,203.72, and many traders expect it to hit 15,000 this year.

Stock-watching has become an obsession in India, one that rivals cricket and Bollywood. Believing in India's stock markets means believing in India itself — and in the country's ability to transform its combination of a young population, a dilapidated infrastructure, chaotic streets and unbridled optimism into a corporate superpower.

For now, markets in India are on a roll, surpassing even the rosiest forecasts, thanks in part to a young, wealthy, expanding middle class that is banking on aggressive corporate growth. While Alan Greenspan, the former chairman of the U.S. Federal Reserve, is offering warnings about China, Indian indexes have hit new highs drawing in foreign investors and Wall Street banks.

Many Indian companies are looking to take advantage of the fervor. This week, the country's largest public offering came to the market, the $2.4 billion float of the real estate company DLF. Later this month, the state bank ICICI plans to tap markets in India and the United States for $5 billion.

The frothy share prices and large initial offerings are exacerbating a debate in India. Market bulls say a fundamental shift is under way as consumers tie their personal wealth more closely to India Inc., paving the way for a more prosperous middle class. But bears have begun to talk about a bubble fueled by naïve optimism and day trading. Indian investors have forgotten, critics say, the heavy losses they suffered after fraud racked the markets in the early 1990s and the technology bubble broke a few years ago.

Source : As stocks soar in India, everyone wants in (International herald Tribune)

BOJ Leaves Rate Unchanged at 0.5 Percent

The Bank of Japan decided Friday to keep a benchmark interest rate unchanged at 0.5 percent, maintaining its ;wait and watch’ policy before moving the rates further up. The bank last changed the benchmark interest rate in February, doubling it from 0.25 percent. That was the first hike since July 2006, when the bank ended five years of near zero interest rates. The low interest rates, to a great extent, helped the word’s second largest economy to come out of a decade of stagnation.

The central bank's decision at the end of a two-day meeting was unanimous. There are expectations that the BOJ would like to wait for more signs of economic strength before tightening policy.

Figures released earlier this week showed that the economy grew at an annual pace of 3.3 percent for the January-March quarter, up from an earlier estimate of 2.4 percent. The nation's unemployment rate has also declined to 3.8 percent in April, the lowest level in nine years.

However, consumer prices have fallen the last three months, raising concerns that Japan might be slipping back into deflation. The core consumer price index edged down 0.1 percent in April, 0.3 percent in March and 0.1 percent in February — which was the first drop in 10 months.

Inflation in China surges to two year high

Chinese inflation rose to its highest level in more than two years, raising renewed concerns about potential fallout of the sizzling growth in the economy. The surge in inflation is mainly driven by soaring prices for pork and other food items. According to government figures released Tuesday, consumer prices rose by 3.4 percent in May, while food prices jumped 8.3 percent from a year ago.

A rise in food prices is politically sensitive, as it will affect the common masses who have not benefited from the prosperity generated by the country's two-decade-old boom. Beijing has adopted a series of monetary measures aimed at cooling the economy and the latest inflation figure may induce further tightening.

Eurozone rates raised to 4%, UK steady at 5.5%

The European Central Bank (ECB) last week raised interest rates for the eurozone to 4% from 3.75% - taking rates in the area to their highest level in six years.

Though the rate increase was widely expected, what was awaited eagerly was cues on further rate actions. At his news conference, ECB president Jean-Claude Trichet said that eurozone monetary policy is "still on the accommodative side", suggesting that more rate hikes may be in the pipeline.

The eurozone economies, especially Germany, have been growing strongly in 2007, unemployment in the eurozone is at its lowest level since the launch of the euro, while confidence is high and business activity is expanding.

Meanwhile, the Bank of England decided to keep its benchmark rate at 5.5%. Even as the bank freezes the rate and goes in a ‘wait and watch’ mode to assess the impact of the series of recent rate hikes, a rate rise later this year remains likely. UK rates have been increased four times since August last year in an attempt to rein in inflation. But price growth still remains strong. While consumer price index (CPI) inflation fell from 3.1% to 2.8% in April, the measure still remains well above the government's target of 2%.

ECB Expected to Raise Key Rate

The European Central Bank is expected to raise its key interest rate by a quarter of a percentage point to 4 percent when it meets today, taking the borrowing cost in the 13-nation euro zone to its highest level in six years. The corresponding benchmark rate is 5.25 percent in US and 5.50 percent in Britain.

Besides the rate decision today, on which there is a near unanimity, the markets will be looking for clues on future rate moves.

The euro zone economy has been growing at a healthy pace, unemployment is at its lowest level since the launch of the euro while business and consumer confidence are up. ECB has been calling for “strong vigilance" to keep inflation under control – a phrase considered by the market as a signal of continued rate increases, typically a quarter of a percent. Year-on-year inflation in the zone was 1.9 percent in May — unchanged from the previous two months, and around the ECB's guidelines of just under 2 percent. While there are concerns about inflationary risks, the ECB will also have to consider global developments such as the problems in the US housing market and uncertainty about Chinese stock markets.

Bernanke expects economic rebound, dashes rate cut hopes

Federal Reserve Chairman Ben Bernanke has re-iterated his belief that the US economy will bounce back from its sluggish performance so far this year to advance at a “moderate pace” in the coming quarters - close to or slightly below the economy's trend rate of expansion, even if the housing slump persists. The US economy's trend or normal growth rate is put at around 3-3.25 percent. The assertion dashes the prevailing expectations that Fed will start cutting interest rates in order to stimulate growth. A section of the market has been expecting that Fed will be forced to cut interest rates later this year, as the economy struggles to come out of the slowdown.

Economic growth in the year's first three months nearly stalled, logging just a 0.6 percent pace. It was the worst quarterly showing in more than four years. Bernanke said he believes some forces that figured prominently in that poor performance — including a bloated trade deficit, cutbacks by businesses in inventory investment and weak federal defense spending — "seem likely to be at least partially reversed in the near term."

The Fed meets next on June 27-28 and many economists predict policymakers will again hold a key interest rate steady at 5.25 percent, where it has been for a year. Many economists think rates will stay where they are for the rest of this year.

Regarding the housing slump, the US Fed Chairman accepted that it may continue to be a drag on economic growth for longer than previously expected. The saving grace is the housing market's problems haven't spread through the broader economy in a significant way. "We have not seen major spillovers from housing onto other sectors of the economy," he observed.

Chinese Stocks : Rebound from Free Fall

China's stocks have been in a virtual free fall since the government tripled the tax on securities trading on May 30. The slide has wiped out more than $500 billion of market value - more than the combined GDP of Taiwan and Singapore.

The benchmark Shanghai index closed more than 8% lower on Monday on concerns that the government is set to launch further measures to cool the gravity-defying rise, including a capital gains tax. On Tuesday, a late rally saw the market rebound to finish more than 2.5% higher after a volatile day of trading that saw a 7% decline earlier in the day.

In an apparent bid to reassure investors, editorials in official newspapers have said that the market's medium- and long-term outlook was still positive, and that the tax hike was merely aimed at speculators. Terming the fall as a healthy short-term correction that won’t hurt the “bull run”, the newspapers have advised investors to take a long-term view of the development of the Chinese capital markets and the importance of the financial reforms.

The meteoric rise of the Chinese stock market has led to widespread fears of a bubble-in-making and warnings of dramatic corrections. Significantly, global markets, which were shaken by a heavy Chinese market sell-off in late February, appear relatively calm to the latest meltdown.

America’s Economy

Sunny outlook, but the weather may turn


THE primary job of any pundit is to forecast all the ways in which things could go wrong. So far, however, the American economy has stubbornly defied the dire prognostications of those expecting bad weather. Economic growth has swayed and faltered. Revised figures announced on Thursday May 31st showed that the economy grew at an annual rate of 0.6% in the first quarter of 2007, less than half the initial estimate. But no matter how close recession seems, somehow the storm clouds never quite break. This may explain why Americans are gaining in confidence, despite a negative household-savings rate, a collapsing housing market, increasing global competition, and a currency that looks decidedly anaemic.

The Conference Board's consumer-confidence index has risen, admittedly from a five-month low. And house prices are still increasing, though at the slowest quarterly rate for ten years, according to the Office of Federal Housing Enterprise Oversight. And even if the American economy is doing all right now, what of the future? This is the question asked in a new survey by the Organisation for Economic Co-operation and Development. The report is surprisingly upbeat on current trends, saying that the economy seems to be weathering the sharp correction in the housing market surprisingly well. Though the Federal Reserve must restrain lingering inflationary pressures without unduly straining growth, the outlook for the short term seems reasonably sunny.

Over the long term, however, America faces gloom: a shrinking labour force. In essence economic growth depends on two things: how fast the number of workers rises and how much more they can produce. For most of the past two decades, both have grown briskly. And the American economy has enjoyed the fastest pace of growth in the developed world.

Since the 2001 recession, however, the labour force has not grown as robustly as after previous downturns. More importantly, labour-force participation is still more than a full percentage point below what it reached in 2000. If the size of the labour force does not track population gains, the remaining workers will have to work harder, or more efficiently, if living standards are to keep rising.

There are reasons to think that the slowdown in labour-force growth is permanent. The great transition of women into the working world, which has boosted participation rates for decades, seems to be over. The proportion of women working is expected to remain roughly stable, or grow only slowly, barring big social or institutional change. Meanwhile, another enormous demographic shift is on the way: the retirement of the baby boomers. That will place an extra burden on tomorrow's workers unless productivity growth is strong enough to plug the gap.

On this point, the OECD is sceptical. American productivity growth has been well above the OECD average for more than a decade and should remain strong. But expected gains will come more slowly than in the past ten years. Unless America undertakes structural reform to make its economy even more competitive, the nation will struggle to support its ever-increasing number of dependants.

The proposed reforms are mostly tricky: trade liberalisation and an end to the distortions caused by farm subsidies; tax reform to broaden the base and remove economically inefficient tax breaks; changes to social security in order to encourage saving and delay retirement; and deep changes to the education system at all levels. Most of these will be politically unpopular. Even improving education, by itself an uncontroversial proposition, generally ends up becoming highly contentious when the details of reform start undercutting powerful interest groups such as the teachers’ unions.

The OECD also wants changes to disability benefits. Some evidence indicates they depress labour-force participation rates. Low-income workers struggling to find jobs may be turning to permanent sick leave when their unemployment benefits run out. But picking on the sick and old to make life easier for young workers will be a hard sell even to the hard-hearted American electorate looking for protection as the clouds begin to gather.

Source : Economist

Will the Bubble Burst?
Chinese Stocks Plunge as Transaction Tax Trebled

China's main share index has fallen 6.5% in Wednesday trading following the government’s decision to triple the tax on stock transactions. The move is seen as an effort to cool the overheated market that has led to fears of a possible bubble.

The Shanghai Composite Index had risen 62% this year to Tuesday's record close and has quadrupled in value since the start of 2006. Last week former Federal Reserve chairman Alan Greenspan warned of a looming correction in the Chinese stock market.

It’s the unprecedented demand from domestic investors that has fueled the rally. There is a flood of fresh money from millions of new investors – including students and pensioners - sinking their savings into the stock market in the hope of super returns as there is a scarcity of other investment options.

The number of stock trading accounts has risen to about 100 million, with tens of thousands being opened every day. It is reported that 300,000 people a day opened brokerage accounts last week. The finance ministry is tripling the stamp tax on stock trading to 0.3 percent, from 0.1 percent, effective Wednesday. Although investors are sanguine about growth prospects and many feel that the correction may be short-lived, there are fears that the government will follow with more steps to curb speculation and excessive flow of money into the stock market.

S&P Beats 1500, Dow Jones at New High

Better-than-expected earnings, positive economic data, M&A news driving the market

The raging bulls continue to scale the mountains as S&P500 beat the 1500 point once again since late 2000 and the Dow made another new high of 13241.38. The economic data continues to paint an optimistic picture of controlled inflation and steady growth. That, along with the great earnings so far, continues to fuel the bulls ahead.

Besides economic and earnings data, what has added to the upbeat mood on the Wall Street is a spate of corporate takeover news. After Rupert Murdoch’s News Corp. offered to buy Wall Street Journal publisher Dow Jones & Co. for $5 billion, there are reports that Microsoft has renewed talks to take over Yahoo Inc. and Reuters Group has received a preliminary takeover offer. The frenzied activities on M&A front are seen as bullish signs for the future of the economy.

China Continues Credit Tightening, Raises Reserve Ratio Again

China’s central bank announced another increase of 0.5 percentage point in the reserve ratio effective May 15. Big banks will now be required to hold 11 percent of their deposits in reserve at the central bank. This is the latest in the series of measures the People’s Bank of China has been taking to cool down credit and investment growth - fourth increase in reserve requirements this year and seventh in past one year. Over the past year, the central bank has also raised interest rates three times - most recently on March 17.

The central bank of the word’s fourth largets economy has been struggling to sterilize a surfeit of liquidity largely flowing in from the burgeoning trade surplus and capital inflows. The excessive liquidity has given rise to worries of potential asset price bubbles. In particular, the easy money has been fueling rally in the domestic stock market which is being considered unsustainable. Chinese stocks have risen 40 percent this year on top of a 130 percent leap in 2006.

Rate hikes imminent in UK

Inflation surges, Pound breaches $2


The British pound has moved through the $2 mark for the first time in nearly 15 years after the latest data showed an unexpected surge in inflation, prompting speculation that interest rates would have to be increased to slow inflation. The last time the $2-level was breached was just before sterling dropped out of the Exchange Rate Mechanism in September 1992. Significantly, Euro is also trading at a two-year high against the dollar and a record high versus the Japanese yen.

According to the data released by the government's Office for National Statistics on Tuesday, consumer price inflation increased to 3.1 percent in March, up from 2.8 percent in February - well above the Bank of England's target of 2 percent. The headline rate of retail price inflation, a wider inflation measure, rose to 4.8 percent from 4.6 percent. The rising inflation rate forced the Bank of England governor to write a letter to the government explaining why inflation has climbed and what the central bank proposes to do about it. The letter said that the central bank is “determined” to set interest rates at a level required to bring inflation back to its 2% target.

The central bank has raised its benchmark rate three times by a quarter percentage point each since August last year in an attempt to contain inflationary pressures. At its last rate-setting meeting earlier this month it kept rates at 5.25%. Now in the wake of the continued surge in inflation, it is expected to lift rates in May to 5.5% and possibly beyond.

HOUSING LOANS - TO FLOAT OR NOT TO FLOAT?

Interest rates in India have been rising relentlessly and home loan borrowers - both existing and potential - are a baffled lot. Those who opted for floating rates a couple of years back when interest rates were falling are now required to shell out larger sums of money (for a longer term in many cases). The potential borrowers - those who are planning to buy a house - are looking on helplessly as both the price of residential property and the housing loan rates move northwards.

Should one opt for a fixed rate or a floating rate loan? How far will the interest rates go from here? Is it wise to lock in a fixed rate when interest rates are so high? As housing loans are long-term in nature - typically 15-20 years - it's important to understand the nature of the risks involved and to evaluate the risk-reward equation - the pros and cons - of all the options.

When you opt for a floating rate loan, you expose yourself to the vagaries of interest rate movements over the entire life of the loan. The expected pay-off for bearing the interest rate risk is to benefit from a possible fall in interest rates. In case of a fixed rate loan, the risk of interest rate movements is borne by the bank, while the borrower is immune to interest rate changes (at least his cash outflows will not change during the entire loan period). However, if interest rates fall, there will be a potential loss as you will earn lesser interest on your savings (deposits) but keep paying higher interest rate on the loan. As banks have to bear the risk in case of fixed rate loans, they price in the risk and such loans are available at a premium campared to floating rates. For example, if a 15 year floating rate loan costs 10% and a fixed rate loan of same maturity is available at 12%, the 2% premium is charged by the bank to cover its risk because it is bearing the interest rate risk in case of a fixed rate.

Interest rate movements are cyclical and a period of 15-20 years is enough to see all the phases of the movement. We can possibly see two to three complete cycles with rates rising, then stabilising at higher levels before starting a downward movement, again falling for some time, then stabilising at lower levels, rising again and so on. If this is the case, ideally it should not make a difference over such a long period of time whether it is a fixed rate or a floating rate. However, it has been seen that while the banks will immediately pass on the rising costs to the borrowers, they don't show the same promptness in giving the benefits of falling interest rates. A repo rate hike as small as 25 basis points, an increase in cash reserve ratio or even a hawkish statement by a Reserve Bank official lead to rate increases of 50 to 100 basis. It is basically the inefficiency or non-transparency of the floating rate mechanism which skews the balance against the borrowers.

As it is difficult to take a call on interest rate movements over a long period of time (even the best forecasting tools cannot predict how interest rates will move over next 15 years), the decision has to be based on a trade-off - how much risk you want to take given your current stage of life (i.e. whether you are young, middle-aged, approaching retirement, etc.) and expected income pattern (i.e. whether you can absorb unexpected changes in the cash outflows). Considering the near tem outlook, it will be advisable to go for a fixed rate. As Indian economy is on a high growth trajectory and doesn't show any signs of fatigue (plus shows some signs of overheating), interest rates are expecetd to keep moving up in near future. However, if you are young and don't mind rising EMIs in the initial few years but would like to benefit from lower interest rates later, you can go for a floating rate. But keep the option to switch to a fixed rate later if required and see its cost.

As an alternative to pure fixed or floating rate loans, some banks and HFCs are also offering hybrid loans. In such loans, a part of the loan will be at a fixed rate and remaining will be floating (ideal for those who are not able to decide between fixed and floating !). Another variant is based on duration - the rate will be fixed for the first 2-3 years and will become floating afterwards. These donot make much sense to me, as anything that looks seemingly attractive will have a premium based on the bank's view on interest rates. Bankers will come up with more innovative products to further confuse the borrowers, as the interest rate scenario gets more hazy. Personlly, I will stick to the idea of fixed rate as it implies a known mothly outgo for a fixed time. No shocks.

And, as for the floating rate loans, I would like to see two changes in the mechanism to make it more meaningful. One, rates are reset at a pre-determined frequency, say every three months or six months (and not every time the bank decides to change its PLR). Two, the rates are linked to some transparent market benchmark and not the arbitrarily determined PLR - for exmaple, average of daily MIBOR over the period or yield on 10 year government bond (plus a spread). These will make the changes more predictable and transparent for the borrower.

I am writing this article based on the request of Amit Shekhar who is planning to buy a house. Hope this will be useful. All the best Amit and all prospective home loan borrowers.

THE SUSPENCE IS OVER..
BoJ Raises Interest Rate

The Bank of Japan has raised its overnight lending rate to 0.5 percent, saying that prolonging a low-interest-rate policy could hamper economic growth. This has been one of the closest calls for the market as opinion was sharply divided amidst strong fourth quarter growth numbers but lingering doubts on sustainability of the economic recovery.

The central bank of the world's second largest economy said in a statement that the the economy is likely to continue its moderate expansion with a virtuous circle of production, income and spending in place. The statement indicated that future adjustments on interest rates will be gradual.

Here are some major points from the statement--

1. Uncertainties over the future course of overseas economies, including that of the United States, are abating, and this is likely to reinforce the prospects of continued increase in corporate profits and business fixed investment.
   
2. With respect to private consumption, the weakness observed in the last summer seems temporary, and it is judged that private consumption is on a moderate increasing trend.
   
3. Consumer prices (excluding fresh food) have been registering small increases on a year-on-year basis, and it is possible that the rate of change will be around zero in the short run. From a longer-term perspective, however, consumer prices are likely to increase as a trend, since the utilization of resources such as production capacity and labor has been increasing and the economic expansion is expected to continue.

WILL FUKUI RAISE INTEREST RATES ?

As Bank of Japan's policy board starts its two-day meeting on 20th February, opinions are divided on whether inerest rates will be raised. The board at its last month's meeting voted 6-3 to keep borrowing costs on hold, with three dissenting members having favoured a rate increase. The central bank of the world's second largest economy ended its zero rate policy last July when it raised the overnight lending rate to 0.25%.

Each piece of economic data since then has been closely monitored and speculations on the timing of next rate increase have been doing the rounds. There are, however, lingering doubts on whether the economy is ready for higher interest rates. The Japanese economy, after growing steadily for about five years, is showing signs of faltering. And, the political leadership has expressed its preference for low interest rates saying that any increase now may hurt the recovery.

According to the latest figures released last week, Japan's economy posted strong growth in the last quarter of 2006 - an annualised rate of 4.8%, highest in almost three years. Consumer spending rose 1.1% rebounding from an equal drop in the July-September period and business spending increased 2.2% in the fourth quarter, following a revised 0.8% increase in the third quarter. However, there are no signs of inflation yet and this makes the central bank's pursuit of a rate increase difficult. Core consumer prices rose 0.1% in December, slowing from 0.2% in the previous month.

Besides the figures of economic growth and inflation, one factor that BoJ will consider is the so-called yen carry trades. This is a transaction that looks quite simple - borrow in yen (at very low rate of interest) and invest in higher-yielding assets in other markets (such as US treasury bonds). But the build up of positions has been so massive that it is being seen as a source of potential financial crisis. So much so that the G-7 group earlier this month warned investors against making "one-way bets". A rapid unwinding of such positions may lead to huge losses for the investors. And may be collapse of many hedge funds?

Dow Jones dream run continues

The Dow Jones Industrial Average reached an all-time high marking a record for the third day in a row, as Federal Reserve Chairman Bernanke painted a broadly optimistic picture of the economy. The 30-stock index has risen seven straight months - the longest winning streak since 1995 - and has gained 2.4% in 2007. It closed at 12,767.57 this Friday, basking in the optimism generated by Bernanke's testimony and positive data on wholesale prices, while shrugging off another set of data that showed a continued slowdown in the housing market.

The Fed Chairman sounded less hawkish in his semi-annual congressional testimony than expected, spurring expectations that interets rates will remain on hold and will be cut later this year. He assessed that there were some indications that inflation pressures were beginning to diminish. Since there was much noise in monthly data, it may be some time before the Fed could be confident that underlying inflation was moderating as anticipated. He noted that core inflation rate remained somewhat elevated. However, if activity expanded over the next year or so at a moderate pace as anticipated by the FOMC, pressures on both labour and product markets should ease modestly. Consumer spending has been the "mainstay" of growth, and the worst housing slump in more than a decade won't have a significant effect on other parts of the economy, Bernanke said.

Reflecting anticipation of lower rates, the yield on the benchmark 10-year U.S. Treasury note has fallen to 4.69 percent.

Inflation in India rises to 6.73%

Defying all the monetary and fiscal measures taken by the government and the central bank in the past few months, inflation continues its upward march. The annual inflation measure based on wholesale price index has returned a reading of 6.73 per cent for the week ended February 3, up from the previous week's 6.58 per cent and highest in about 2 years. What's worse is the inflation estimate for the week ended Dec. 9 has been revised to 5.63 percent from 5.32 percent. It's a usual practice to revise the inflation data with a lag of two months on additional price data.

The rise in inflation figures is being driven by the rapid economic growth and credit expansion, together with supply constraints in agricultural commodities and food articles. While the RBI has been pursuing a gradual tightening to avoid liquidity overhang, the central government has taken measures like ban on export of certain items, easing import restrictions, cuts on customs duties, restriction on futures trading of some essential commodities and cut in petrol and diesel prices. With the combined effect of these measures, inflation numbers should moderate over next couple of months. However, as the economy has taken off into an unchartered territory of high growth, it is expected that the central bank will continue to raise rates and do everything at its disposal to actively manage the liquidity.

Bond markets have been in a virtual free fall in this scenario of rising inflation and monetary tightening (and 'to be continued' signs). The benchmark 10 year yield is above 8 per cent.

China raises reserve ratio

In a move to temper the staggering pace of economic growth and curb inflationary pressures, China's central bank has raised the reserve ratio by 50 basis points. Commercial banks will now be required to set aside 10% of their deposits in cash reserves. This is the second hike in 2007 and fifth since last July.

The People's Bank of China is concerned that continued growth will stoke consumer prices as the economy marks a record trade surplus. Mounting trade surplus along with strong FDI inflows are adding to the excessive liquidity in the banking system and the central bank has taken a slew of measures to slow the pace of lending.

"Since 2006, the People's Bank of China has used a combination of monetary tools to soak up liquidity in the banking system and has achieved some results," the central bank said in a statement posted on its web site. "But the surplus in international payments remains large and the pressure on loan expansion is still relatively big so it is necessary to again increase the reserve ratio," it said.

China's economy, the world's fourth-largest, expanded 10.7% in 2006. And consumer prices returned a rise of 2.2% for the month of January - lower than the previous month's 2.8%, still high enough to call for continued tightening bias.

War on inflation intensifies - CRR raised again

The Reserve Bank of India has announced another hike in the cash reserve ratio, as inflation continues to surge despite a slew of monetary and fiscal measures taken in the last couple of months. The 50 bps hike takes the CRR - the balance that banks need to maintain with the central bank - to 6% and will be effective in two phases of 25 bps each, first phase kicking in on 17th February and second phase starting 3rd March. The move will impound about Rs. 14,000 crore out of the banks' deposits.

It was on 8th December 2006 that the RBI had last raised CRR by 50 bps, absorbing around Rs 13,500 crore. This was followed by a 25 bps increase in the repo rate on 31st January. RBI is worried about the spiraling inflation and has been taking measures to avoid overheating of the economy as it continues to grow ferociously. See a detailed analysis of the interest rate scenario and RBI's actions here.

The Indian economy is expected to grow at 9.2% in FY2007 on the back of 9% growth last year. The annual wholesale inflation rate has touched 6.58% for the week ended 27th January - a full percentage point higher than RBI’s target for the current fiscal.

Besides the surging inflation numbers, the recent move seems to have been triggered by the rise in liquidity from RBI's intervention in the forex market in the last few days. RBI has been buying dollars to halt the appreciating rupee as a strong domestic currency affects the country's exports.

The CRR hike is bound to have an impact on banks' lending rates, including those on home loans, auto loans and personal loans. In the weeks following the recent repo rate hike, some of the private sector banks have already raised their lending rates. Public sector banks, which constitute three-quarters of India’s banking industry refrained from doing so as they were advised by the finance minister to maintain the current rates, especially on housing loans. They may have to follow suit now, as the liquidity squeeze puts pressure on their cost of funds.

ECB holds interest rate, may raise in March

The European Central Bank has decided to keep its key interest rates on hold at 3.5%, waiting to see if its last increase in December can keep inflation at bay and hinting that a hike may come in March. The ECB President Jean-Claude Trichet said "strong vigilance" was needed to avoid "risks to price stability" – a statement being seen by the market as a clear signal for a rate hike next month. The term ‘vigilance’ seems to have acquired a new meaning for the followers of Trichet-speak - each of the last six times Trichet used the word vigilance, a rate increase was handed down the next month.

The key eurozone economies have had a strong start to 2007. Unemployment has fallen in France and Germany, with consumer confidence remaining strong, despite Germany's decision to increase value added tax (VAT) from 16% to 19%. While growth is expected to remain strong, wage pressures are mounting. The latest round of pay negotiations in Germany will be keenly watched. Inflation in the euro zone was 1.9 percent in December for a third straight month, at its recommended level of just under 2 percent.

Meanwhile, Bank of England also held official interest rates steady at 5.25 percent after a surprise increase last month of a quarter of a percentage point.