Fears of CRR hike may haunt market

The spectre of inflation, which many bet would rise to double digits soon, is expected to keep shares of interest-rate-sensitive sectors such as banks and real estate under pressure. Investors fear the Reserve Bank of India (RBI), as part of its efforts to contain rising inflation, would resort to more measures to make banks’ lending rates dearer. Analysts expect the central bank to hike the cash reserve ratio (CRR) next - the minimum cash that banks need to keep with RBI, after the recent hike in repo-the rate at which banks borrow from RBI for short-term. As a CRR hike would result in banks having lesser money at their disposal for lending, the move is expected to keep interest rates higher and further slowdown borrowing by corporates and individuals. By keeping interest rates high, RBI intends to curb spending, and in turn keep prices lower. “The wide and persistent gap between RBI’s WPI inflation target (of 5.5%) and the likely trajectory suggests more policy tightening ahead to keep inflation expectations anchored. We expect another 25 basis point (bps) hike in the repo rate in Q3 (Oct-Dec) 2008 and 100-bps hike in CRR during this financial year,” Lehman Brothers economist Sonal Varma said in a client note. Inflation, measured by wholesale price index (WPI), jumped to a 7-year high of 8.75% in the week to May 31, after rising 8.24% in the previous week. Investors fear that the negative impact of higher lending rates may not be restricted to banks and real estate, but would rub off on the entire economy. Such concerns over slowdown in economic growth are expected to keep the market choppy this week too. “If the course of monetary policy is to be corrected by controlling money supply, interest rates will go up; exchange rates will appreciate leading to further slowdown in growth,” Merrill Lynch equity strategist Vijay Gaba said in a client note. A weaker rupee against the US dollar makes import of oil and other critical raw materials costlier, thereby widening trade deficits while boosting exports. These parameters of India’s economic conditions are of significance, as they are closely watched by foreign investors, including institutions, which have been key to India’s recent bull run. So far in 2008, foreign institutions have net-sold Indian shares worth Rs 21,832.60 on account of India’s deteriorating economic conditions. The performance of dollar in the coming weeks will largely depend on the outcome of the Fed meet on June 24-25. If the Fed does not cut benchmark rates further in the meet, analysts expect the dollar to weaken, at least, temporarily.