Mumbai: The Reserve Bank of India (RBI) on Tuesday kept its key policy rate unchanged, continuing its fight against persistently high inflation that has been stoked by inadequate rains, but surprised the markets by slashing the statutory liquidity ratio (SLR), or the portion of deposits that banks need to compulsorily invest in government bonds, by one percentage point to 23% to ease pressure on liquidity.
Below-normal rain in the June-September monsoon threatens India’s farm output adding to inflationary pressures. Citing global and domestic risks, the Indian central bank pared its growth projection for fiscal 2013 to 6.5% from 7.3%, and raised the year-end inflation forecast to 7% from 6.5%.
RBI governor D Subbarao, deputy governors K C Chakrabarty and Subir Gokarn, addressing a press conference after the RBI’s 1st quarter monetary policy review meeting in Mumbai (PTI)
The SLR cut, which takes effect in the fortnight beginning 11 August, theoretically makes available about Rs 62,000 crore for the banking system to lend to corporations, but this is unlikely to happen as the banks currently hold over 30% in government bonds. They can either offer the excess SLR holdings to RBI as collateral to borrow from its repo window, or liquidate the excess bond holdings and use the money for giving loans.
C. Rangarajan, chairman of the Prime Minister’s economic advisory council, endorsed the central bank’s action, saying the cut in SLR will allow banks to increase lending to companies.
Top bankers said a one percentage point reduction in SLR may help improve liquidity, but may not immediately push up lending or bring down the cost of money.
“Every bank wants to maintain a cushion of 3% on SLR. Thus, even when we have a higher SLR holding, we cannot liquidate the cushion. The reduction in SLR helps us realize liquidity even after maintaining the cushion,” State Bank of India chairman Pratip Chaudhuri said.
K.R. Kamath, chairman and managing director of Punjab National Bank, said unless deposit rates drop, “I will not be able to cut my lending rate”.
Chanda Kochhar, managing director and chief executive officer of ICICI Bank Ltd, said lenders will have to watch the market. “How soon banks are able to release liquidity through this SLR reduction, one will have to watch and based on that rate decisions have to be taken,” she said.
A cut in SLR led to an immediate spike in the benchmark 10-year paper yield from 8.16% to 8.25%. By the end of trading hours, the yield was 8.247%, against 8.141% on Monday.
The Sensex, the bellwether equity index of BSE, fell 0.81% to 17,004.09 points after the policy announcement, but recovered to close at 17,236.18, up 0.54% from the previous close, but the Bankex, BSE’s banking industry index, fell 0.28%.
Industry associations were disappointed with the RBI move. “A cut in policy rates, at this juncture, would have done much to infuse liquidity in the system which is facing tight liquidity conditions, (and) spur investments among companies,” said Chandrajit Banerjee, director general of Confederation of Indian Industry.
RBI felt a rate cut at this stage would fuel inflation and not support growth. It admitted that monetary policy tightening in the last two years has contributed to hurting growth, but highlighted that besides monetary policy, “several factors”, too, have played a “significant role” in slowing economic expansion, implying a lack of credible steps from the Union government in this regard.
In the past, too, RBI has called for efforts from the government’s side to improve fiscal discipline to make monetary policy more effective.
“In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth,” RBI governor D. Subbarao said. “The primary focus of monetary policy remains inflation control.”
RBI, which made a two-stage cut in banks’ cash reserve ratio (CRR) in January and reversed its policy stance in April by cutting its policy rate by half a percentage point, said the focus on inflation was a necessary factor to “secure a sustainable growth path over the medium term”. CRR is the portion of bank deposits kept with RBI.
Economists lauded the central bank’s decision to hold rates and blamed the government for not taking adequate steps to improve the fiscal situation.
“Given the clear risks of both further weakness in the rupee and a speedy return to double-digit inflation if the monsoon continues to disappoint, RBI may deliver even less,” said Richard Iley, chief Asia economist at BNP Paribas SA.
According to Leif Eskesen, chief economist for India and the Association of Southeast Asian Nations, and Prithviraj Srinivas, economics associate, at Hongkong and Shanghai Banking Corp. Ltd, it’s unlikely the central bank will cut rates unless the Centre takes step to improve the fiscal position. “It is clearly difficult for RBI to cut rates in the absence of progress on fiscal consolidation and structural reform,” they said.
“Only those banks which are on the fringe of 24% will have some benefit,” said Madan Sabnavis, an economist at rating firm CARE Ratings.
Any cut in CRR would have brought more money into the system, stoking inflation, but by cutting SLR, the central bank is actually helping banks that have a lower SLR level, said Rupa Rege-Nitsure, chief economist at Bank of Baroda.
“RBI seems to be signalling that banks should lessen their dependence on bulk deposits and high-cost certificates of deposit,” said Rege-Nitsure.
The central bank raised its key lending rate 13 times since March 2010 till the April cut to fight persistently high inflation, but is yet to succeed in its battle to rein in prices.
After staying close to double digits for nearly the whole of last year, wholesale price inflation eased to 7.25% in June and so-called core inflation—or non-food, non-oil inflation—eased to 4.9% in May and June. But retail inflation, measured by the Consumer Price Index, continues to remain in double digits.
“Going forward, further pressure on non-food manufactured products inflation cannot be ruled out,” RBI said. Inflation faces risks from external markets, a deficient monsoon and pressure on input prices on account of exchange rate movements.
“As the multiple constraints to growth are addressed, the Reserve Bank will stand ready to act appropriately,” RBI said. It will announce its mid-quarter policy review on 17 September.