Emboldended with having kept inflation under check, and further tightening the lid firmly on inflation, the Reserve Bank of India (RBI), on Tuesday, caught the banking sector off-guard by increasing the Cash Reserve Ratio (CRR) by 50 basis points to 7.0 per cent with effect from the fortnight beginning August 4, 2007.
As a result, the central bank, put a dampner on bank’s lending and investment operations for the third time this year in an express effort to soak up the cash and pin the inflation down  as a result of strong capital inflows, knocking bonds and stocks lower. 
Briefing reporters, RBI Governor Yaga Venugopal Reddy, justified the move stating “the recent financial market developments in India and potential uncertainties in global markets warranted higher priority for managing appropriate liquidity conditions at current juncture.
“The CRR hike would restrict the liquidity in the system up to Rs 16,000 crore,” he pointed out. Consequently, banks must now put aside 7 per cent of their deposits as reserves starting August 4.
Lifts ceiling
The RBI, which also held its benchmark interest rate at a five-year high of 7.75 per cent, however, made no changes in the bank rates, keeping both the reverse repo rate and repo rate unchanged. Bank rate was left unchanged at 6 per cent, repo at 7.75 per cent and reverse repo at 6 per cent. With today’s move India joined China in restricting bank lending this week as two fastest-growing major economies struggle to prevent floods of cash from spurring inflation, which the RBI wants to keep well below 5 per cent. Even as RBI kept both Reverse Repo and Repo Rates unchanged, it withdrew the ceiling of Rs 3,000 crore on daily reverse repo which it would absorb each day from bankers with effect from Monday, August 6, 2007. The limit spurred banks with spare cash to lend more in money market, making borrowing cheaper.
Despite the robust economic growth of  9.4 per cent in previous year, the RBI, however, retained its earlier projection of 8.5 per cent growth for current fiscal stating the price rise will be contained below five per cent. 
“While growth in industry and services has accelerated in recent years, the stagnation in productivity levels of major crops and overall volatility of agriculture output have emerged as issues of serious policy concern,” Mr Reddy observed.
Common man belied
Though the inflation rate based on wholesale prices has been pulled down to 4.4 per cent from 5.9 per cent in March, the RBI, however, warned that pressures on price line remained, warranting a vigilant and proactive monetary policy. 
The hike in CRR, though, has belied expectations of common man for an immediate fall in interest rates in view of easy liquidity position and low inflation. On what is his message to the common man was, Mr Reddy said, “he should be rest assured that price stability is a necessary condition for growth.”
Mr Reddy, also hastened to point out that there is no policy direction as far as bank rates are concerned. “It is for each bank to take a call on the impact of CRR on their lending rates,” he pointed out while indicating that RBI monetary policy actions are not likely to have any major impact on flush liquidity conditions.
The impact of the increase in CRR, on which the RBI does not pay any interest, would be offset by greater absorption through reverse repo window at 6 per cent, and with the expected increase in short-term money market rates to desired levels.
Although there was no rate hikes in previous policy meeting on April 24, the central bank had raised benchmark lending and borrowing rates five times and CRR thrice since mid-2006.
Any further increase in consumer interest rates are also unlikely as the benchmark lending rates have been spared from a hike.
RBI maintained the economic growth projection at 8.5 per cent for 2007-08, and said there was no change in outlook for inflation — which it seeks to keep within 4-4.5 per cent in medium term and 5 per cent for the fiscal. The annual rate of inflation on July 14 was 4.41 per cent.