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Asian stocks up on rate cuts

Nov 3, 2008

Asian markets are all trading strong currently. Major gains are seen in benchmark indices of Hong Kong (up 5%), Singapore (5%) and Indonesia (9%). Strength in stocks is seemingly being spurred by the interest rate cuts announced by central banks across the world last week - US, Japan, China, South Korea, Taiwan and India - to ease the credit crisis.

As reported on Bloomberg, central bankers in the UK, Europe and Australia are meeting this week to consider their options on rate cuts.

In the meanwhile, the Reserve Bank Of India (RBI) announced multiple measures to add liquidity to the system late last week. As a matter of fact, it was for the first time since 1997 that the RBI deployed all three of its main tools - CRR, SLR and repo rate (all defined below) - to perk up the credit markets and enable growth.

The Indian central bank reduced the CRR by 1% to 5.5%, the repo rate by 0.5% to 7.5%, and the SLR by 1% to 24%.

These weekend announcements from the RBI came after inter-bank lending rates climbed to as high as 21% on the back of dwindling cash in the banking system. This was due to the continued large scale FII pullout and RBI's actions of stemming the rupee's decline by selling dollars. The foreign Institutional Investors (FIIs) for instance have pulled out almost US$ 12.8 bn from Indian equities this year after the US$ 17 bn investment they did in 2007.

Following this, the rupee has depreciated by almost 24% this year thereby being the second-worst performer among key Asian currencies, after the South Korean won.

Having taken the abovementioned actions, the RBI has also expressed some satisfaction over the inflation (measured in terms of wholesale price index or WPI) coming down to 10.7% levels and global commodity prices, including crude oil prices, cooling off. However, the central bank has reasoned that the global financial turmoil has had unforeseen effects on domestic financial markets and reinforced the importance of focusing on preserving financial stability.

Given that cash remains in short supply in the Indian banking system and there being a continuous outflow of foreign funds, the RBI might persist with its interest rate lowering stance going forward. The receding inflation shall also provide some relief to the central bank in pursuing its near term ambitions.

Note - Key definitions (Source: Wikipedia)
CRR - Cash Reserve Ratio is the amount of minimum reserves each bank must hold to customer deposits and notes. These reserves are designed to satisfy withdrawal demands, and would normally be in the form of currency stored in a bank vault, or with a central bank.

SLR - Statutory Liquidity Ratio is the amount which a bank has to maintain in the form of cash, gold or approved securities. The objectives of SLR are to restrict the expansion of bank credit, to augment the investment of the banks in Government securities, and to ensure solvency of banks.

Repo rate - This is the rate at which banks borrow for the short term from the RBI.

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