RBI's CRR and its impact

Sensex was down by 400 points, decrease of about 2.9% to finish the trading daya (Dec 11, 2006) at 13,399.43. The Bankex took the heavy toll of all the sectors at 6.43%.

The drop in the stock market is mainly due to RBI's raise in the Cash Reserve Rate (CRR). Cash Reserve rate is the percentage of Bank deposits to be kept at RBI. RBI raised the CRR on friday by 50 basis points (0.5%), implementing the raise in two stages of 25 basis points (0.25%) each, one to be implemented on Dec 23rd, 2006 and another on Jan 06, 2007.

Why did RBI raise CRR ? What is the impact ?
India has been a clocking a high growth. The GDP for the quarter ending July-Sept 2006 stood at 9.4%. The growth in GDP has come with an increased inflation and the inflation stood at 5.30 percent in the 12 months to Nov. 25. Finance minister Mr.Chidambaram had earlier suggested to manage the inflation by supply side constraints. By increasing the CRR, RBI will be able to extract Rs 13,500 crores from the banks. This means lesser money available with the banks, so banks have to increase the lending rates to sustain their margins. With increase in cost of loans, corporate borrowing from banks will take a hit and eventually slowing the investment. But the increase in CRR means more money available with RBI and Government can spend this surplus money to curb the inflation. Recent measures like reduction in oil prices, import of wheat from Australia and reduction is sugar exports is expected to bring down the overheated economy.