Reserve Bank of India (RBI) governor D. Subbarao’s no-action second quarterly review of monetary policy has not come as a surprise. In fact, on Monday, I had written in this column that RBI should wait for the next round of cut in its policy rates. Frankly, Subbarao has done enough in the past three months to tackle the liquidity crisis and economic slowdown and he can afford to wait and watch.
Prima facie, RBI has cut its repo rate, or the rate at which it injects liquidity into the system, by 350 basis points to 5.5% since October. One basis point is one-hundredth of a percentage point. It has also cut the reverse repo rate, or the rate at which it drains liquidity from the system, by 200 basis points to 4%. But for all practical purposes the cut in policy rate is much deeper—a massive 500 basis points—from 9% to 4%. This has been done by changing the operating policy rate from repo rate to reverse repo rate.
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In a liquidity-starved financial system, repo rate is the policy rate as banks knock at RBI’s door for money, but in a liquidity-flush system, reverse repo becomes the operating rate. In other words, RBI needs to create ample liquidity in the system to position the reverse repo rate as the operating rate. The central bank has done this by paring bank’s cash reserve ratio (CRR), or the portion of deposits that commercial banks need to keep with the central bank, by 400 basis points to 5% and banks’ statutory liquidity ratio (SLR), or the percentage of deposits banks need to invest in government securities, by 100 basis points to 24%.
The combined move released Rs2 trillion into the system. Other liquidity-boosting measures have injected additional Rs2.28 trillion. One needs to see the impact of these measures before aggressively bringing down the rates further, even though the downside risk to growth has been growing.
Indeed, the inflation may drop to 3% or even less in the next few months and economic growth could be even less than 7% for fiscal 2009, but these projections have already been priced in the current level of policy rates and CRR. RBI had last cut its policy rate and banks’ CRR on 2 January. The challenge before the Indian central bank now is to persuade commercial banks to pass on the benefit of rate cuts to the borrowers. It won’t be a cakewalk as banks are finding it difficult to bring down their deposit rates with small savings rates being competitive and returns tax-free.
Does this mean RBI has pressed the pause button on lowering the policy rate? Certainly not. But one may not expect a rate cut very soon unless there is a compelling reason. Will RBI wait till April when it announces its annual monetary policy for fiscal 2010? It is anybody’s guess but in all probability, there may not be any change in rates for a while. Also, from now on, any rate cut will be incremental, by 25 or at best 50 basis points.
The current policy rate, at 4%, is in no way in a restrictive zone. It can stimulate growth if commercial banks pass on the benefit to borrowers and appropriate fiscal measures accompany it.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org