Credit Policy Analysis

The Reserve Bank of India announced its third quarter review of monetary policy. The bank raised the Cash Reserve Ratio (CRR) by 75 bps to 5.75% and left the key policy rates, repo and reverse repo unchanged. The hike in CRR was above the street expectation of a 50 bps hike and the market reacted in a knee jerk manner, however has recovered because of a stronger growth outlook.

Some of the key highlights form the policy documents are:

· The Indian monetary authority sounded very bullish on growth in the third quarterly review of its annual monetary policy for FY10 and raised the growth projection for the economy to 7.5%, way ahead of its forecast of 6% with upside bias given in the last policy review three months ago

· The figure is also substantially higher compared with median forecast of 6.9% in the survey of professional forecasts release by the RBI on Thursday

· The deficient monsoon rainfall and drought conditions in several parts of the country have accentuated the pressure on food prices, pushing up the overall inflation rate – both of the WPI and consumer price indices (CPIs)

· The central bank says that even though a baseline scenario is comforting a number of downside risks to growth and upside risks to inflation are there

o There is still uncertainty about the pace and shape of global recovery and it is too dependent on public spending and will unravel if governments around the world withdraw their fiscal stimuli prematurely

o Expectations of softening domestic inflation are contingent on food prices moderating. This, in turn, depends significantly on the performance of the monsoon which if remains inadequate could continue to intensify inflationary pressures

o As growth accelerates and the output gap closes, excess liquidity, if allowed to persist, may exacerbate inflation expectation

Analysis:

The two-phased CRR hike will soak Rs 36000 crore from the banking system, that was the only negative that the RBI policy document. The way the banking and the real estate sector stock recovered clearly highlights the fact that the market has really taken this policy in a positive way, however one should remain cautious as there was nothing positive in the document which fundamentally could lead to a rally like today.