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The Credit Policy review statement released by the Reserve Bank of India (RBI) recently had a limited

impact on the stock markets. Contrary to the expectations of any relief on the interest
rate front, the RBI hiked the cash reserve ratio (CRR) by 0.5 percentage points to 7.5 per cent. The
CRR is the ratio of interest-free cash reserves to be kept by banks with the RBI. Key lending and
borrowing rates (repo, reverse repo) and bank rates are unchanged.
Unveiling the busy season monetary policy, the RBI has sent strong signals that it would continue its
strict approach in order to ensure price stability, credit quality and orderly conditions in the
financial markets. The RBI has reaffirmed its motive to keep inflation in the range of 4-4.5 percent with
an objective to bring it down to three percent in the medium term.

Initially, the stock markets closed lower after the RBI increased the CRR for banks. The Sensex and
the S&P CNX Nifty were dragged down. The 50-basis-point CRR hike was already discounted by the
market. The policy supports growth by trying to achieve price stability and sterilise capital flows rather
than moderate them. The CRR hike is a pre-emptive measure in anticipation of more flows. The focus
is on the management of liquidity. The scope for further reduction in rates is not there for the time
Analysts are positive on corporate bonds because the spread is quite attractive. The short-end yield
could rise by around 10-15 basis points mainly because of the fact that those yields are driven by
liquidity in the system which is already tight. Markets are positive on five and ten-year corporate
This policy is particular significant as this is the busy season credit policy, and is being watched by
corporates for directions on interest rates. As the inflation concern is far from over, the RBI has
decided not to lower interest rates. With high interest rates, the cost of borrowing for corporates also
increases. As a result of these high costs, the bottom lines of corporates are adversely affected. As
such, the stocks of highly levered companies take a hit. These companies who are working on huge
amounts of borrowed capital or are planning to borrow money to finance their operations and
expansion plans, are affected adversely.
The CRR increase is meant to reduce the funds in the banking system available to be given as loans.
This had a negative effect particularly on stocks in the auto sector and the banking sector itself. There
was some profit booking by investors as the market was expecting some relief on repo rates. As it did
not come through, the investors indulged in profit booking.
According to the RBI, there is excess liquidity in the system. This is mainly because of strong inflows
of foreign funds into India. With the huge inflow of dollars, the rupee has been getting stronger against
the dollar. As a result, the export dominated companies and sectors are feeling the pinch. Their
bottom lines are getting eroded. This is reflected in their stocks. The IT industry is particularly affected
as most of their billing is US dollar denominated.
On the other hand, the import-intensive industries are gaining because now they have to pay lesser in
dollars than before to import their equipment and raw materials. This improves their bottom lines. This
is particularly true for capital goods industries. As such, stocks of such companies are seeing an