Short Term Pain for Long Term Gain....

In its toughest step to defend the rupee after the Lehman Brothers crisis in 2008, the Reserve Bank of India (RBI) has moved to push up short-term rates in the money markets which will choke speculators and attract dollars to India. But these measures will cause collateral damage to the economy by pushing up short term borrowing for companies by a couple of percentage points and cause huge losses for bond investors.
In a late-evening statement, the RBI said that it would limit its lending of overnight funds to banks to Rs 75,000 crore. If banks need more they will have to pay a higher interest rate of 10.25%.
Bankers say an immediate outcome of this will be that the cost of overnight funds will cross 10% as their current overnight borrowing is over Rs 93,000 crore.
This, in turn, will translate into higher short-term borrowing for companies. The sensex which crossed 20,000 points on hopes of a rate cut triggered by lower inflation could lose its gains as hopes of a rate cut have vanished.

The measures were announced after RBI governor D Subbarao rushed to Delhi on a day when the Prime Minister and finance minister held meetings, ostensibly to address the exchange rate issue amid dwindling foreign exchange reserves.
Despite stringent trading restrictions by the RBI, the rupee lost 27 paise to close at 59.90 after touching over 61-levels last week.
“The market perception of a likely tapering of US quantitative easing has triggered outflows of portfolio investment. Consequently, the rupee has depreciated markedly in the last six weeks. Countries with large current account deficits, such as India, have been particularly affected despite their relatively promising economic fundamentals,” the central bank said in a statement.

SHORT-TERM PAIN, LONG-TERM GAIN?
MEASURES
Overnight banks borrowing from RBI capped at 75,000 crore
Additional borrowing to be at 10.25%
RBI to sell bonds worth 12,000 crore to make rupees scarce
Bank rate raised from 8.25% to 10.25%
IMPLICATIONS
Hopes of an interest rate cut dashed as RBI sacrifices short-term growth for rupee stability
Rupee-$ exchange rate may stabilize
Cost of overnight funds in money markets could cross 10%
Bond prices will crash as investors expect better returns
Mutual fund schemes that invest in bonds will take a hit
Cost of short-term borrowing for corporates to rise
Widespread speculation in forex, especially dollars, could be curbed