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Business News/ Opinion / Blogs/  RBI’s SLR cut is symbolic of better days ahead
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RBI’s SLR cut is symbolic of better days ahead

The latest round of SLR cut is to ensure banks have more resources in their kitty when credit demands picks up

If indeed inflationary expectations come down, we may see a rate cut by the end of the current fiscal year, if not in December. Photo: Abhijit Bhatlekar/MintPremium
If indeed inflationary expectations come down, we may see a rate cut by the end of the current fiscal year, if not in December. Photo: Abhijit Bhatlekar/Mint

In sync with market expectations, the Indian central bank on Tuesday left its key policy rate as well as banks’ cash reserve ratio (CRR), or the portion of deposits that commercial banks need to keep with the Reserve Bank of India (RBI), unchanged. But it has cut the banks’ mandatory investment in government bonds, or the so-called statutory liquidity ratio (SLR), by half a percentage point to 22.5%. The last time the central bank cut the SLR—by 1 percentage point—was in August 2012.

The latest round of SLR cut is to ensure banks have more resources in their kitty when credit demands picks up in Asia’s third-largest economy. The credit growth had been around 14% in last two years, lowest in the past one decade, and less than half of what we had seen in fiscal years 2006 and 2007 when India’s economy grew at 9.5% and 9.6%, respectively. Currently, the credit deposit ratio in the banking system is close to 77%. This means, for every 100 deposit, the banks are lending 77.

The cut in SLR also illustrates the RBI’s confidence in the new government’s commitment to fiscal consolidation. In the current fiscal year, the government is set to borrow a record 5.97 trillion (so far 1.52 trillion has been raised from the market) after borrowing 5.64 trillion last year and 5.58 trillion the year before. These are all gross borrowing figures. Net of redemptions of bonds that matured, the average annual borrowing amount since fiscal year 2012 hovers around 4.57 trillion.

However, at this point, the cut in SLR is more symbolic and yet another step to signify RBI’s commitment to reforms. The average holding of government bonds by the banking system is around 29% of their deposits when the floor for such holding is 23%. So, a half a percentage point in SLR holdings will not goad them to rush to give loans to corporations and stop picking up government bonds from the market. This merely creates headroom for resources, which banks can use when the credit demand rises.

Indeed, RBI’s concerns over a sub-normal monsoon and shrinkage in the production of consumer durables and capital goods and moderation in corporate sales remain, but the policy statement exuded confidence in revival of growth impulse in the economy. “The decisive election result, together with improved sentiment should… create a conducive environment for policy actions and a revival in… demand as well as a gradual recovery of growth during… the year," the central bank said. So, it has stuck to its 5-6% growth projection for the year, with the risk “evenly balanced" around the estimate of 5.5%. In the April policy, RBI had seen “downward risk" to the 5.5% projection of Central Statistics Office.

Similarly, the risks to its 8% retail inflation forecast by January 2015 also remain “broadly balanced". After dropping to 8.1% in February, its lowest since January 2012, retail inflation, or inflation based on the consumer price index, accelerated 8.59% in April, driven by food prices. The RBI expects it to rise further in May but seems happy with the fact that the non-food, non-oil, or the so-called core inflation is edging down. Both core retail inflation as well as core wholesale inflation, or manufactured goods inflation, eased marginally in April by 10 basis points each. Core retail inflation dropped to 7.7% from 7.8% and core wholesale inflation dropped from 3.5% to 3.4%. One basis point is one-hundredth of a percentage point.

Finally, “if the economy stays on course, further policy tightening will not be warranted," the regulator said, and, if inflation drops below the RBI’s estimate, there will be “headroom for an easing of the policy stance". This is definitely less hawkish a policy statement compared with the April document, which was silent on growth and emphatically said its stance “will be firmly focused on keeping the economy on a disinflationary glide path" in accordance with the Urjit Patel committee recommendations. It had also said, “if inflation continues along the intended glide path, further policy tightening in the near term is not anticipated at this juncture," but did not hint at “easing of the policy" in case inflation drops below what RBI anticipates.

This policy sends a strong signal that interest rates in India have peaked and can only now go down. RBI governor Raghuram Rajan also seems to be convinced that the Bharatiya Janata Party (BJP)-led government will address the supply-side bottlenecks to fight inflation and push the implementation of the stalled projects to change the investment climate. Rajan had met both finance minister Arun Jaitley and Prime Minister Narendra Modi before formulating this bi-monthly policy and the document clearly reflects the Modi effect. If indeed inflationary expectations come down, we may see a rate cut by the end of the current fiscal year, if not in December.

Banker’s Trust Realtime is a frequent blog by Tamal Bandyopadhyay, who writes a popular weekly column Banker’s Trust.​

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Published: 03 Jun 2014, 02:18 PM IST
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