RBI HAWKISH STANCE

REPO UP BY 25 BASIS POINTS

RBI today unexpectedly raised the policy rate by 0.25 per cent as it kept its focus on controlling inflation, which it felt would be above the expected levels in the current fiscal. RBI Governor Raghuram Rajan in his maiden policy review, however, eased liquidity though a reduction in the marginal standing facility rate, at which banks borrow from the central bank, by 0.75 per cent to 9.5 per cent. The repo rate or the short term lending rate has been increased by 25 basis points to 7.5 per cent from 7.25 per cent with immediate effect. He kept the cash reserve ratio (CRR), the portion of deposits that banks are required to maintain with the RBI in cash, unchanged at 4 per cent. At the same time, the RBI reduced the minimum daily maintenance of CRR from 99 per cent of the requirement to 95 per cent effective from September 21, a move aimed at inducing liquidity into the system.

INFLATION MAIN CONCERN

"The need to anchor inflation and inflation expectations has to be set against the fragile state of the industrial sector and urban demand. Keeping all this in view, bringing down inflation to more tolerable levels warrants raising the repo rate by 25 basis points immediately," Rajan said in the mid-quarter policy review statement. Rajan said WPI inflation will be higher than initially projected over the rest of the year in the absence of an appropriate policy response. What is equally worrisome is that inflation at the retail level, measured by the CPI, has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence, he said. Stating that economic growth has weakened with continuing sluggishness in industrial activity and services, the RBI said the pace of infrastructure project completion is subdued and the start of new projects remains muted. "Consequently, growth is trailing below potential and the output gap is widening. Some pick-up is expected on account of the brightening prospects for agriculture due to kharif output and the upturn in exports," it said. Rajan said concerns on the current account deficit have been mitigated by steps taken by the government and the RBI. Also, steps have been taken to improve the environment for external financing, turning the focus to internal determinants of the value of the rupee, primarily the fiscal deficit and domestic inflation, he said. Rajan said the timing and direction of further actions on exceptional measures will be contingent upon exchange market stability and can be two-way. "Further actions need not be announced only on policy dates. However, any further change in the minimum daily maintenance of the CRR is not contemplated," he added.

"NDF" THE MAIN CULPRIT
Domestic forex market needs to be deepened and made more competitive as non-deliverable forwards is sucking out liquidity from the onshore place, increasing the rupee volatility, RBI Governor Rahuram Rajan said. "To some extent it (NDF) draws away liquidity from our market. We have to make sure we provide deep and functioning market so that there is no need to establish a parallel market outside. There is certainly competition for the Indian market and competition generally is a good thing. We should try and deepen our markets to draw in more activity here," the newly appointed Governor said.
The non-deliverable forwards (NDF) market is a foreign exchange derivative instrument traded over-the-counter currencies that are not freely convertible, like the rupee, are traded here. RBI has no control over this market, which has huge volume and operates round-the-clock. Domestic financial institutions are not allowed to trade in this market.

MARKET REACTS SHAPLY

The benchmark S&P BSE Sensex fell 383 points today, the most in three weeks, after RBI Governor Raghuram Rajan unexpectedly raised a key interest rate to combat inflation and partially rolled back liquidity tightening measures. Realty, bank and auto stocks fell on concern higher interest rates would make loans more expensive and reduce their business. ICICI Bank and HDFC Bank together contributed more than 120 points to the Sensex's fall. The 30-share Sensex, which initially moved in a narrow band, plunged 595 points to 20,051.43 after the rate hike. It recovered some ground on selective buying by institutional investors to end at 20,263.71, a fall of 382.93 points or 1.85 per cent. The index had declined 651 points on September 3. The broader 50-stock CNX Nifty index on the National Stock Exchange dipped by 103.45 points, or 1.69 per cent, to 6,012.10. The MCX Stock Exchange's SX40 index ended at 12,026.41, down 205.69 points.

Interest sensitive stocks tank
Interest-rate sensitive bank, realty and auto stocks fell up to 11.5 per cent after RBI unexpectedly raised the policy rate by 0.25 per cent, triggering all-round selling in the stock market. Realty stocks were the worst hit. Shares of DLF tanked 11.55 per cent, while HDIL lost 8.47 per cent and Indiabulls Real Estate slumped 7.01 per cent on the BSE. Out of 13-listed realty stocks, ten ended the day with losses. Led by the losses in these stocks, the BSE realty index settled 6.53 per cent lower at 1,287.12, the worst performer among the 13 sectoral indices. Analysts said that rate-sensitive sectors such as realty, banking and auto were hit hard the most after RBI announcement as a higher cost of credit would reduce their revenue. Banking stocks also faced the heat, with Yes Bank plummeting 7.90 per cent, Union Bank (7.89 per cent), PNB (7.31 per cent), ICICI Bank (4.78 per cent), HDFC Bank (3.63 per cent) and SBI (3.44 per cent). Following this, the BSE banking index closed the day with 4.18 per cent loss at 12,166.86.  The auto index was down 1.58 per cent to 11,203.65.