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India central bank tightens cash conditions

Mumbai, October 30, 2007

India's central bank unexpectedly raised banks' reserve requirements on Tuesday to absorb inflation-fuelling excess cash stemming from capital inflows, but left its key interest rates unchanged.

The Reserve Bank of India (RBI) raised the cash reserve ratio (CRR) by 50 basis points to 7.5 percent, taking it to its highest level since 2001.

It said while inflation had moderated in the September quarter, headline inflation was emerging from a prolonged trough and oil and food prices were a risk.

"Financial markets continue to experience conditions of surplus liquidity, warranting an appropriate response in order to ensure orderly market conditions on an enduring basis," the central bank said in its policy review.

Reflecting the policy tightening, the partially convertible rupee rose slightly to 39.38/39 per dollar after the decision from 39.40/41 beforehand.

The benchmark 10-year federal bond yield rose 3 basis points to 7.84 percent.

Analysts said the central bank appeared to be expecting more capital inflows, which would prompt it to intervene further to curb a rise in the rupee that could result, even though the stock market regulator tightened investment rules for some foreign investors last week.

The rupee is trading at its highest levels in more than 9 years and the central bank has been buying dollars and selling rupees heavily in a bid to rein in the currency. But this process has contributed to surplus cash in the banking system.

"The issue raised repeatedly in the past week is how to manage capital flows and risks of financial contagion from a more uncertain global outlook," said Han-Sia Yeo, currency strategist at Bank of America.

"I think the strategy will continue to be erect the fences."    

The central bank kept its key repo rate at 7.75 percent as expected. It left its growth forecast for the fiscal year ending March 2008 unchanged at 8.5 percent.

Analysts in a Reuters poll last week forecast that the central bank would leave rates unchanged to monitor the inflation trend and to see what the US Federal Reserve decides at a policy review on Wednesday.

The central bank left the reverse repo rate, the rate at which it absorbs excess cash from banks, unchanged at 6.0 percent. The bank rate, which is used to price medium- and long-term loans, remained at 6.0 percent.

The central bank raised its short-term lending rate five times between mid-2006 and the end of March this year.

The CRR increase takes effect from Nov. 10, when it will stand at its highest level since Nov 2001. It was last raised in August this year and when the rise comes into effect it will have gone up 250 basis points since December. - Reuters




Tags: India | Rates | Reserve Bank of India |

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