RBI & SEBI action on the Indian Stock Market

• The Reserve Bank of India on Monday evening (6^th Oct) cut the cash reserve ratio by 50bp to 8.5%. The cut will come into effect from 11^th October 2008 and is estimated to release about Rs20,000 cr into the system.
• The last time RBI had cut CRR was in August 2003 and since then it has been continuously tightening.
• Declining crude oil and other commodity prices and marginal decline in WPI gives some room to RBI to reduce CRR.

Reason for the cut

• Liquidity has been tight for quite some time now with call rate (interbank rate) ruling in double digits, and banks borrowing from the RBI at 9% on an average of Rs 70,000 cr daily for past three weeks.
• Liquidity crunch has been affecting corporates as they had to borrow at much higher rate. This move will cushion Indian banks against the impact of global liquidity crisis.
• Central banks around the world are trying to improve liquidity by injecting billions of dollars into the system. Even Fed is now expected to cut rate. In Australia, RBA has cut rate by 50-100 bps today to support growth. Even Bank of England is expected to follow suit before this weekend.

Implication

• This will definitely bring relief and help cool the money market.
• The move demonstrates RBI’s readiness and ability to move quickly and ahead of expectations to systemic problems
• This will provide a boost to banks’ earnings as they would be able to transfer 0.5% of assets from zero-yielding deposits to loans yielding 10-11%.
• This move definitely is a turning point in rate cycle. We belief interest rate has peaked but with inflation still much above RBI’s comfort level, there might not be any immediate benchmark rate cuts.
• GDP growth is expected to moderate in FY09 and this move will not be enough to accelerate the growth.

SEBI eases PN curbs

• On Monday (6^th October), Sebi removed restrictions on issuing participatory notes (popularly known as P-notes) by FIIs, where the underlying asset is a stock or a derivative instrument listed on the Indian exchange.
• It scrapped the rule which stipulated P-notes could account only for up to 40% of the value of assets held by a foreign fund.
• The regulator has also decided to set up a committee to take a re-look at the whole FII trading process in the Indian market. (In October 2007, Sebi had imposed the curbs on p-notes to cool down markets and to calm a strengthening rupee by slowing money inflows).
• Sebi also decided to enhance the limit of holding shares in a recognized stock exchange from 5% to 15% for six categories of shareholders: public financial institutions, stock exchanges, depositories, clearing corporations, banks and insurance companies.
• Sebi also decided to encourage promotion of dedicated exchanges for securities issued by SMEs.

Reason for this move

• Indian market has declined to a level below 12K yesterday on global cues. Foreign funds have sold Indian stocks worth a net $9.4 billion so far in 2008, compared to record inflows of $17.4 billion last year.
• The rupee, on the other hand, slid to a over 5 1/2-year low to Rs.47.80 on Monday.
• It is believed that removing the restriction will have a positive impact on market.

Bottomline

• It is a very encouraging move and will have a long term positive impact on the market. But foreign funds may not start moving immediately into Indian market as the developed world is reeling under a worst financial crisis and a looming recession (or significant slowdown)