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CRR: What's the impact? - Views on News from Equitymaster
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  • Sep 14, 2004

    CRR: What's the impact?

    The Reserve Bank of India (RBI), over the weekend, decided to hike the Cash Requirement Ratio (CRR) in two fortnightly tranches of 25 basis points each to raise it to 5%. This move is not surprising, given the high liquidity in the economy and the rising inflation. To put things in perspective, inflation, as per the government's CMP was targeted to be arrested at nearly 5%. But given that the same is currently hovering at over 8%, some steps were needed to control inflation. This move comes as the first and is one of the most predictable ones, which could have been adopted by the Central Bank.

    The RBI along with the rise in CRR also reduced the interest payable (by the RBI) on the CRR deposits held by the banks at RBI, from the current 6% (Bank Rate) to 3.5%. Although banks have refrained from giving clear signals of a possible interest rate hike, it is likely that the industry witnesses some northward shift in lending rates in the short-term.

    Let us now analyse the impact of a possible rate hike on India Inc.:

    • Banking: During FY04, the net income of banks were boosted by robust treasury incomes. Over the last 3-4 years, low credit offtake from the industry and falling interest rate regime compelled banks to park their idle cash in government bonds well over the statutory limits (CRR and SLR). Over this period, banks were able to book huge profits on their G-Sec portfolios. However, they are currently faced with a rising interest rate regime, which is likely to wipe out a considerable part of their G-Sec profits. This will have an adverse impact on their networth as well. RBI's recent measure is likely to further suck out liquidity from the markets, which may put pressure on banks to hike interest rates in the short-term.

      Inflation affecting banks
      Other income (Rs m) 1QFY04 1QFY05 (%) Change
      SBI 17,529 15,387 -12.2%
      Oriental Bank 1,817 998 -45.1%
      Corporation Bank 1,257 1,001 -20.4%
      HDFC Bank 1,322 1,080 -18.3%
      IDBI Bank 428 417 -2.6%
      UTI Bank 1,503 1,101 -26.7%
      * Source: Equitymaster Research

    • Manufacturing industry: The last three years' soft interest rate regime had a positive impact on India Inc, as the industry witnessed lower interest outgo. An upward shift in interest rates is likely to impact the capital expenditure plans of most companies. However, we would like to reiterate that while interest rates are likely to rise, they will probably not reach the 14%-15% levels seen in the past. The debt burden on corporates is also substantially much lower, thus further enhancing their interest payment ability. Most corporates have generated significant cash flows to fund a part of their expansion plans as well. This will reduce their reliance on debt. Considering all these aspects, we find that rising interest rates are likely to have limited impact on the Indian manufacturing sector in the near term.

    • Infrastructure: The country's budget has laid special emphasis on infrastructure activities with over Rs 400 bn being earmarked for the same. Large construction activities coupled with agricultural projects (irrigation) are on the anvil. A hike in interest rates could result in postponement of these plans. This is likely to impact companies in the infrastructure segment such as steel, cement and energy. Power projects, which are capital intensive and have longer gestation periods, are likely to be worst hit in the face of rising interest rates. However we would like to point out that this could only happen in case of a significant rise in interest rates. As mentioned earlier we do not expect interest rates to rise significantly over the long-term and hence the impact on the infrastructure sector in terms of higher costs may be limited.

    We believe interest rates are not likely to move up substantially in the long-term as there is still substantial liquidity in the banking system, which means that banks are still sufficiently liquid to lend. On the consumer side (retail borrowers), a small hike in interest rate may have a 'sentiment' effect rather than impacting demand for housing and car loans in the long-term. While global economic recovery has been wavering, due to rising crude oil and commodities prices, we have seen a sobering trend for the same over the last few weeks. Consequently, we believe that inflation is likely to decline after the short-term spike seen recently. Over the long-term, we believe that India Inc is in a better position to weather a rise in interest rates provided there are no further spikes. Read more on the hike in CRR by the RBI.



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