Mumbai: The Reserve Bank of India (RBI) expectedly held off from raising interest rates while it lowered the amount that banks need to invest in government bonds in its mid-quarter monetary policy on Thursday to ease pressure on liquidity.
The central bank also announced a buyback of government bonds to increase the availability of cash in the system. This marks the first pause in key rate increases in this calendar year, during which they have been raised six times to fight inflation, which was at 7.48% in November.
“Even as inflation has moderated, it remains significantly above the comfort level of the Reserve Bank,” it said in the review. There is hence no change in the monetary policy stance, which favours further tightening.
“The risk to the Reserve Bank’s projection of 5.5% inflation by March 2011 is on the upside,” the report said, while noting that domestic growth “momentum remains strong” and reinforces the central bank’s projection of “8.5% for real GDP (gross domestic product) growth for 2010-11.”
Analysts expect RBI to raise interest rates at its January review given the concern over prices.
“Inflationary pressures persist both from domestic demand and higher global commodity prices,” the bank said, adding that the “pace of decline in food price inflation has been slower than expected.”
As the economy expands, primary liquidity is needed and will be provided “in a manner consistent with the monetary policy stance,” RBI said in the review. “Such provision of liquidity should not be construed as a change in the monetary policy stance since inflation continues to remain a major concern.”
The statutory liquidity ratio (SLR), or the proportion of deposits that banks need to invest in government bonds, has been cut by one percentage point to 24% by RBI, which will also buy back such paper worth Rs 48,000 crore in the next one month, freeing up cash. Since the mid-year review on 2 November, banks have been borrowing an average Rs 1.04 trillion daily from RBI to meet cash requirements. While the SLR allows the banking system as a whole to lower government bond holdings by around Rs 50,000 crore, it is unlikely to have any substantial impact as most banks have an SLR holding of 28% or above.
In any case, RBI has already allowed banks to keep their SLR holdings at 23% instead of the currently mandatory 25%. Banks have been allowed to do so until 28 January and use the excess bonds as collateral for borrowing from RBI. This is a temporary measure while the cut in SLR is permanent.
The buyback plan cheered the bond market and yields on the most-traded 12-year security fell at least 6 basis points to 8.04% soon after the announcement. Bond prices rise as yields fall. One basis point is one-hundredth of a percentage point. It closed at 7.99% against Wednesday’s closing of 8.08%.
“The bond buyback will finally soothe the nerves of the bond market. The bond yields should remain range-bound in the coming weeks and should not fluctuate much from the present level,” said G.A. Tadas, managing director of IDBI Gilts Ltd, a bond trading firm.
The Bombay Stock Exchange’s benchmark index, the Sensex, rose 1.10% to 19,864.85 on Thursday. The Bankex, the index for banks, closed at 12,958.88 points, up 1.86%.
“We can expect a 25 basis point (bps) hike in interest rates in the January policy,” said Indranil Pan, chief economist at Kotak Mahindra Bank Ltd. “RBI will likely stay away from excessive tightening and just 25 bps is our bet in this fiscal.”
HSBC Singapore’s Leif Lybecker Eskesen, chief economist for India and the Association of Southeast Asian Nations (Asean), wrote in a research report after the policy was announced that the bank expects an additional 1.25 percentage point increase in the key rate by end-2011, with the first rise coming in the January quarter.
Nomura economist Sonal Verma wrote in her report that she expects RBI to hike rates by 0.25 percentage point in January and to raise them by 0.75 percentage point between September 2011 and March 2012 as inflation exceeds estimates.
Standard Chartered Bank’s chief economist Samiran Chakraborty does not see a rate hike in January “unless something really awry happens between now and then... It’s not yet peak of the rate hiking cycle, but any more hikes will be a function of inflation trajectory.”
Bankers are of the view that lending rates will remain stable until RBI resumes increasing policy rates. In the last two weeks, banks have raised lending and deposit rates.
“Whether there will be a change in lending and deposit rates depends upon how the market reacts to the policy moves,” said Punjab National Bank chairman K.R. Kamath. “Market is so dynamic these days... we have to take a view on how it behaves before taking a call. Although it looks like nothing immediately is going to happen on rate issues.”
Bank of Baroda chairman and managing director M.D. Mallya said, “At the moment there is no provocation for hiking rates.”
The expectation that the government will start spending from its cash balance of Rs 90,000 crore with RBI will help address liquidity concerns in the coming months, he said.
RBI kept its repo and reverse repo rates, at which the central bank injects or drains liquidity, respectively, unchanged at 6.25% and 5.25% respectively. The cash reserve ratio, the proportion of deposits that banks need to keep with RBI, was also kept unchanged at 6%.
Inflation, as measured by the Wholesale Price Index, has slowed of late on account of the high base effect and easing food prices. It moderated to a 11-month low of 7.48% in November from 8.58% in October and 8.8% in August.
The apex bank has raised its repo rate by 1.5 percentage points and reverse repo rate by 2 percentage points this year.