Volume 3

IMS Proschool - Financial Planning Weekly – Volume 3

News of this week

In its quarterly review of monetary policy, the central bank marked up Repo — the rate at which the RBI lends funds to banks — by 50 basis points to 9 per cent, the highest in seven years, and the Cash Reserve Ratio by 25 basis points to 9 per cent by keeping the Reverse repo, bank rate unchanged at 6%.
While the hike in repo will be with immediate effect, the increase in CRR, which is expected to suck out about Rs 9,000 crore from the system, will be effective from the fortnight beginning August 30, 2008.

What is Repo?
Repo is the repurchase agreement executed by Banks with RBI (by depositing their Govt. securities) towards the short term borrowings. Banks willing to borrow short-term money (through repo) from the Reserve Bank of India will have to pay 9 per cent interest by paying interest to RBI.(9%)

What is Reverse Repo?
Reverse Repo is exactly opposite of Repo where in Banks park their excess cash with RBI for getting some returns on it. (6%).

What is CRR?
CRR (Cash Reserve Ratio) is a cash equivalent to the % of time and demand deposits which every bank is supposed to deposit with RBI towards it’s liquidity.
According to Central Bank this measure was taken to tame the galloping inflation (which is at 11.98% for week ending 31st July). This is the third hike in CRR as well as repo in the current fiscal. With this hawkish measure, the RBI hopes to bring down inflation to 7 % by March 2009 from around 12 % at present.

How does it help contain Inflation?
1) Borrowings for banks become costlier, and hence they have to make lending to public as well as Industries dearer. The expected rate of PLR (Public Lending Rate) is around 15%. This will reduce the borrowings and hence curtail the money supply in the system.
2) Other effects are less spending hence reduction in demand side.
3) Increase in CRR sucks out Rs. 9,000 crores from the system leaving less money with the banks for lending

General Effects:
a. Increase in Home and Car Loan rates by about 50 to 100 basis point Will have direct effect on CAR & Real estate property sale.
b. Increase in cost of goods and services which shall result in reduced consumption
c. All the industries depending upon heavy loan structure to face more interest burden & hence face pressures on profitability, postponement in new investment plans & hence slow down in employment and overall GDP growth
d. As estimated by RBI the GDP growth rate to come down to 7.5 to 8%
e. This shall have direct effect on the valuation of companies and hence on share market.

Some thoughts for the week?
1) What are the other measures you think RBI and or Govt. to deploy to contain the Inflation?
2) How does people at large can contribute to tame the inflation?
3) With wide gap between Repo & Reverse Repo should Banks park their surpluses via Reverse Repo route or follow some other route?
4) What’s a role of call money rates in this situation?
5) What is the roll of a financial planner to preserve capital and offer reasonable post tax and
inflation adjusted returns?

Kindly post your comments here