Mumbai: The Reserve Bank of India (RBI) on Tuesday cut the cash reserve ratio (CRR) by a quarter percentage point, freeing up additional funds to the tune of Rs.17,500 crore for commercial banks to lend to companies and consumers. It kept its key policy rate unchanged as it pursues the battle against stubbornly high inflation, but hinted at a possible rate cut in the fourth quarter of the current fiscal, beginning January.
RBI, which has maintained that concerns over inflation outweigh worries over slowing economic growth, reduced CRR, the portion of deposits that banks have to maintain with the central bank, to 4.25% in its quarterly monetary policy announcement. The repo rate, at which banks borrow overnight funds from RBI, was left at 8%.
The markets gave the policy the thumbs-down with stocks, bonds and the rupee sliding. Finance minister P. Chidambaram, who on Monday unveiled a medium-term fiscal consolidation plan aimed at cutting the fiscal deficit in a bid to persuade RBI into lowering borrowing costs, made no effort to hide his disappointment.
“Growth is as much a concern as inflation,” Chidambaram said, reacting to the central bank’s stance. “The government has to walk alone to face the challenge of growth.”
Led by declines in banking and other interest-rate-sensitive stocks, benchmark indices fell to five-week lows. The 30-share bellwether index of BSE, the Sensex, closed down 1.1% at 18,430.85 points, and the 50-share Nifty index of the National Stock Exchange lost 1.19% to end at 5.597.90 points, the sharpest fall in three months.
State Bank of India (SBI), the nation’s largest lender by assets, lost 4.43% to close at Rs.2,074.15.
The yield on the benchmark 10-year government bond rose to 8.18% from its previous close of 8.13%. Bond prices and yields move in opposite directions.
The rupee fell to as low as 54.19 per dollar from the previous close of 54.07 after opening at 54.09. It recouped its losses to end at 53.96 per dollar.
While the policy document makes clear that inflation is the foremost objective of monetary policy, governor D. Subbarao, himself a former finance ministry bureaucrat, said in an interview after presenting the policy: “We are equally worried about high inflation and slowing growth. It’s not correct to say that growth slowdown is not a worry for us.”
At a press conference earlier in the day, Subbarao said, “I think both the government and RBI share concerns about growth and inflation... The only difference is the balancing of growth-inflation dynamics.”
The apex bank increased the inflation forecast for the fiscal year-end to 7.5% from 7%, acknowledging risks emerging from supply constraints, the rupee’s depreciation that makes imports more expensive and higher rural and urban wages.
It also lowered the economic growth forecast for the second time this year to 5.8% from 6.5% and much lower than the 7.3% predicted in its annual policy review in April.
Going ahead, “while risks to this trajectory remain, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13,” RBI said. “The above policy guidance will, however, be conditioned by the evolving growth-inflation dynamics.”
India’s wholesale price inflation accelerated to 7.81% in September from 7.55% in August, while economic growth was a modest 5.5% in the June quarter after hitting a nine-year low of 5.3% in the March quarter.
Core inflation, a key indicator for RBI to decide policy action, stood at 5.6% in August and September. Core inflation is a measure of inflation that excludes food and fuel prices that tend to be volatile.
The latest CRR cut is on top of three reductions in the measure by a cumulative 150 basis points (bps) since January as part of an effort by RBI to ease liquidity in the banking system. A basis point is one-hundredth of a percentage point.
“The reduction in CRR is intended to preempt a prospective tightening of liquidity conditions, thereby keeping liquidity comfortable to support growth,” said RBI.
Chanda Kochhar, managing director and chief executive officer of ICICI Bank Ltd, India’s largest private sector lender, said the CRR cut won’t have any immediate impact on banks’ interest rates.
“The 175 bps cut in CRR (this year) has led to the reduction in cost of funds for banks and also a reduction in base rates. But every step (by RBI) may not be enough to warrant a step (by banks) the next day,” Kochhar said. She expects lending rates to drop by the end of the fiscal.
“Given the low level of investment activity in both manufacturing and infrastructure, particularly in power, RBI may have to bite the bullet sooner rather than later and take a call to lower interest rates,” said Y.M. Deosthalee, chairman and managing director of L&T Finance Holdings Ltd.
Economists welcomed RBI’s decision to keep rates unchanged.
The decision to keep the monetary policy rates unchanged was “spot on and the prudent thing to do”, said Leif Eskesen, chief economist for India and the Association of South-East Asian Nations at HSBC Holdings Plc.
“Inflation risks are still lingering, which has been evident from the uptrend in inflation in recent months. The adjustment in fuel prices will also add to inflation and possibly lift inflation expectations, and the supply-led nature of the slowdown has left capacity tight,” Eskesen said in a note to clients.
The government has eased foreign investment norms in sectors such as retail and aviation since September. To rein in the fiscal deficit, it raised the price of diesel and limited the supply of subsidized cooking gas to six cylinders per household a year. The fiscal consolidation plan unveiled by Chidambaram envisages reducing the fiscal deficit to 4.8% of gross domestic product in the next financial year from an estimated 5.3% in the current year.
RBI wants speedy implementation of these measures to enable the central bank to reciprocate through monetary policy.
Unless both the fiscal and current account deficits decline significantly, it will be difficult for RBI to cut rates, said Indranil Pan, chief economist at Kotak Mahindra Bank Ltd.
“RBI makes it most apparent in its guidance that the current trajectory of inflation should indicate a rise, before easing in the last quarter of the financial year. In this context, we continue to stick to our long-held view that a repo rate easing could happen only in the fourth quarter of the financial year,” Pan said in an emailed comment. “We also stick to our view of a 50 bs incremental repo rate cut in this financial year.”
Rajeev Malik, senior economist at CLSA, was critical of RBI for signalling a likely rate cut in the last quarter of the fiscal.
“Its main purpose is to compromise the effectiveness of the decision of staying put on policy rates,” Malik said in a research note. “The tone of the policy statement is also less hawkish than before, although it still understandably frets about the risks to the inflation outlook. Frankly, many of these risks will not evaporate by early next year, so one wonders about RBI’s guidance of easing in the first quarter of 2013.”
Besides the CRR cut, RBI also announced tightening in some regulations, most importantly those governing the restructuring of loans by banks. The central bank said banks will have to keep aside more money to cover restructured loans; it increased provisions for restructured standard accounts to 2.75% of the loan from the existing 2%.
The increase in provisioning is likely to hit public sector banks the most. SBI, Punjab National Bank (PNB) and Bank of Baroda will likely be the worst hit.
“SBI will have to keep aside an additional Rs.300 crore because of the increase in provisioning,” chairman Pratip Chaudhuri said, adding that RBI has agreed for more consultations on the subject.
PNB chairman and managing director K.R. Kamath said the increase in provisioning was “unpleasant”.
“The past records show that just 15% of restructured loans turn non-performing. This move by RBI is to bring the standard restructured loan provisioning closer to the provisioning on substandard loans, but by this the central bank should not make restructuring a disincentive for banks,” Kamath.
RBI also asked banks to put in place a system to guard against risks arising out of unhedged foreign currency exposures of companies.
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