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RBI cuts reserve ratio to ease cash squeeze

MUMBAI (Reuters) - The Reserve Bank of India (RBI) on Monday said it would cut the cash reserve ratio (CRR) for banks to alleviate a cash squeeze caused by the global financial crisis, but said it was not relaxing its fight to rein in double-digit inflation.

A broker looks at a terminal while trading at a stock brokerage firm in Mumbai October 6, 2008. The RBI on Monday said it would cut the cash reserve ratio (CRR) for banks to alleviate a cash squeeze caused by the global financial crisis, but said it was not relaxing its fight to rein in double-digit inflation. REUTERS/Arko Datta

In a surprise announcement after market hours, the RBI said the CRR would be cut by 50 basis points to 8.5 percent from Oct. 11, a step it said would release 200 billion rupees ($4.2 billion) into the banking system.

The RBI, which has been injecting record amounts of funds into the market via its daily operations, said the move was ad-hoc and temporary, and would be continuously reviewed.

It was welcomed by traders and analysts looking for relief after the stock market fell 5.8 percent to its lowest close since Sept. 2006, and the rupee fell to its weakest against the dollar since Feb. 2003.

“This was sort of overdue, the system was freezing up,” said Abheek Barua, chief economist at HDFC Bank.

“It is to address the liquidity crisis, it was indeed a crisis, and RBI has sent out a strong signal that it is concerned.”

It was the first reduction since June 2003 in the CRR, which is the proportion of deposits banks need to keep with the central bank in reserve, and came ahead of a policy review scheduled for Oct. 24.

Before Monday, the RBI had raised banks’ reserve requirement by 150 basis points in 2008, with the most recent rise taking effect in late August.

POLICY PRIORITY

While the cut was a welcome, analysts said market reaction on Tuesday would also depend on what happened in overseas markets.

“It is a kind of relief, and will take care of immediate liquidity,” said Deven Choksey, chief executive of brokerage K.R. Choksey, but added he thought the move was a couple of weeks too late.

“It will have a positive impact on the market, but we think more steps are needed.”

Central banks around the globe have been pumping money into banking systems to try to restart stalled capital markets as the financial crisis has worsened. Among Asian central banks, those in Australia, China Indonesia, New Zealand and Taiwan also cut their key interest rates last month.

“In view of the evolving environment of heightened uncertainty, volatility in global markets and the dangers of potential spillovers to domestic equity and currency markets, liquidity management will continue to receive priority in the hierarchy of policy objectives over the period ahead,” the Reserve Bank said in its statement.

Earlier on Monday, the capital market regulator removed most curbs on indirect investment notes used by foreign funds to help encourage inflows.

CASH SQUEEZE

Since mid-September, the central bank has introduced a second daily repo auction to add funds to a squeezed market, and over the last three trading days, Wednesday, Friday and Monday, it has injected an average of 908 billion rupees per day.

The cash rate hit an 18-month high of 17.50 percent last Wednesday, and closed at 11.00/25 percent on Monday, still above the repo rate of 9 percent.

“This market is already in the ICU. It requires oxygen which has been provided by the Reserve Bank of India,” said K. Ramkumar, head of fixed income at Sundaram BNP Paribas.

However, the central bank added it was not lowering its guard on inflation, which hit 12.63 percent in early August, the highest annual rate in the 13-½ years of the current data series, but has since eased to just under 12 percent.

The RBI also raised its key short-term lending rate three times in June and July, increasing it by 125 basis points to a seven-year high of 9.0 percent to contain inflation.

“The overriding priority for monetary policy is to eschew any further intensification of inflationary pressures and to firmly anchor inflation expectations,” the RBI said.

$1 = 47.8 rupees

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