Rupee stays steady despite S&P downgrade: Standard & Poor's downgraded India's foreign currency rating to BB from BB+ citing "the fading prospects for meaningful fiscal adjustment, weakening the sustainability of recent economic growth rates and potentially further raising the country's already high debt burden". The rupee initially reacted sliding to 42.37/$ but climbed back to 42.29/$. The positive news on the external front was the authority given to president Clinton by both houses of the US Congress to waive the economic sanctions imposed on India and Pakistan. Though a waiver is expected to be linked to the two countries participating in nuclear treaties, the likelihood of removal of sanctions has definitely improved.

Credit policy: What is in store? Governor Bimal Jalan hadstated in the April credit policy that "henceforth it is proposed to give much greater importance to structural measures in the credit and monetary policy statement at the beginning of the financial year. Short-term credit and regulatory measures are subject to change at short notice. The (October) statement will generally be confined to a review of monetary developments in the first half of the year and to such changes as may be necessary in monetarys projections in the second half of the year.."

Hence, it is clear that we may not expect any major structural changes for the current year. The policy is likely to spell out a time-table to strengthen banking sector norms. The CAR target is likely to be raised to 9 per cent by fiscal 2000 and 10 per cent by 2002, with the possibility of 5 per cent market risk weight assigned to government securities as recommended by the second Narasimham Committee Report. In addition, a schedule may be drawn to implement the Asset-Liability Management System by banks in aphased manner, the draft guidelines of which have already been circulated among banks.

Regarding the second half of the current year, the main policy objectives would be to ensure availability of sufficient bank credit to the commercial sector and to control inflation. The necessity of controlling any excessive volatility in the currency markets would provide the backdrop. Keeping this in mind, we do not expect any immediate change in the short term reference rates. The last hike in repo rates and CRR was in response to a sharp depreciation in the value of the rupee. Though the rupee has since stabilised, world currency markets remain very volatile. The recent downgrade by S&P is likely to deter any easing of the short term stance. The short-term liquidity position is comfortable as reflected in repos with the RBI. There does not seem to be a strong enough case to reduce CRR.

The bank rate is the rate at which general refinance is available to banks and other rates such as export finance rates are linkedto it. However, in practice, banks rarely avail of refinance; bank rate has functioned mainly as a reference rate for bank PLRs. With the industrial slowdown resulting in lower demand for credit, any hike in PLRs could result in a further squeeze.

Moreover, with an inflow of over Rs 13,000 crore to the banking sector from RIBs (after accounting for the CRR requirement) below 9.5 per cent cost, the case for an increase in lending rates becomes weaker. In sum, we do not lexpect any change in repo rate, CRR or bank rate.

Broad money (M3) growth has averaged 18 per cent in the first half, well above the targeted 15-15.5 per cent for the full year. Part of the growth is due to RBI inflows. In addition, WPI inflation at 8 per cent plus and CPI inflation at 15 per cent threaten to become politically sensitive issues.

However, considering that current inflation is essentially a supply-side problem and the low level of manufacturing product group inflation (5.5 per cent) reflects lack of industrial demand, RBIis unlikely to contract money supply to rein in inflation.

Hold on to short-term securities: The net inflow into the banking system this week is estimated at Rs 50 crore. With an easing in interest rates unlikely in the credit policy, we advise investors to overweigh the short end.