There was no surprise in the monetary measures announced by the Reserve Bank of India (RBI) on the weekend. The draft of the policy had been in circulation in the past few days since RBI governor D. Subbarao attended the high-profile meeting in Delhi where former finance minister (and now home minister) P. Chidambaram as well as Planning Commission deputy chairman Montek Singh Ahluwalia were also present. First, the bureaucrats of the finance ministry started talking about rate cuts—the instruments, quantum of cuts as well as the day on which such measures would be announced. As if that was not enough, to talk up the sagging economy, commerce minister Kamal Nath on Friday volunteered to discuss the contours of the RBI measures in greater detail. The real surprise is that, after all these, Subbarao met the press on Saturday and RBI even put an embargo on the live telecast of the conference by television channels.
The Indian central bank has cut both its policy rates—the repo rate at which it injects liquidity into the financial system and the reverse repo rate at which it sucks out excess liquidity—by an identical margin, 100 basis points. One basis point is one-hundredth of a percentage point. With this, the repo rate is now 6.5%, a level last seen in January 2006. At 5%, the reverse repo rate is at a three-and-a-half year low. But the corridor between the repo rate and the reverse repo rate still remains 150 basis points. This will narrow if RBI decides to cut the repo rate further in January when it unveils its quarterly monetary policy.
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RBI has never cut both the policy rates by such a wide margin in its history. By doing so, it has bought a temporary reprieve and can afford to tinker with the repo rate next month. The gap between the reverse repo and the repo rate, or the so-called liquidity adjustment facility, or LAF, corridor, theoretically determines the volatility of the overnight call money market from where banks borrow to tide over their temporary asset-liability mismatches. The call money rates, which rose to 20% in September, should now range between 5% and 6.5%.
For the first time since he took over as RBI governor in September, Subbarao has pledged to “maintain a comfortable liquidity position” and “see that the weighted average overnight money market rate is maintained within the repo-reverse repo corridor”. This makes it amply clear that RBI will not hesitate to cut banks’ cash reserve ratio (CRR), or the portion of bank deposits kept with the central bank, to ensure liquidity in the system. It cut CRR by 350 basis points in October and November, releasing Rs1.4 trillion.
Another comfort factor for the banking industry is Subbarao’s comment that the reverse repo rate is the signal rate now. As I mentioned in this column on Saturday, since RBI infuses money into the system at the repo rate, this is the policy rate of a liquidity-starved economy. But if RBI wants to give a signal that liquidity is here to stay, the reverse repo rate, or the rate at which it sucks out liquidity, should be the policy rate. The governor has done that. This will definitely encourage banks to lend and dampen their enthusiasm to park excess money with the central bank as they will earn less from this.
Apart from the rate cuts, RBI also announced some refinance measures to address two critical pressure points of the sagging Indian economy. It will give a Rs7,000 crore line to the Small Industries Development Bank of India, or Sidbi, to meet the credit needs of the micro and small enterprises that have millions of employees on their pay rolls. The refinance window will remain open till 31 March, 2010. The small business units can avail of the loan for 90 days and roll over the facility. Another Rs4,000 crore refinance line is being granted to the apex mortgage regulator, the National Housing Bank, or NHB.
I am not sure whether such facilities are effective or Rs11,000 crore is enough to take care of the needs of these two sectors. One way of encouraging banks to lend to some pockets that have become the victims of the economic downturn could be accepting bank loans as collateral while extending its money line. Currently, Indian banks can avail of RBI funds by offering government bonds as collateral. This restricts banks’ borrowing ability. Under the law, they need to invest 24% of their deposits in government bonds, known as statutory liquidity ratio, or SLR. Only bonds held by banks in excess of 24% SLR can be used as collateral for availing of the RBI money. Indeed, the regulator has given some concessions for banks’ fund raising to support mutual funds and non-banking finance companies. If it wants banks to lend to productive sectors and, particularly infrastructure, which need long-term money, it can accept the loans as collaterals and extend credit to the banks. This will boost banks’ confidence, address the liquidity problem and allow RBI to cut the level of SLR in future.
The Saturday RBI package kept mum on the infrastructure sector. But the economy should not lose hope as the government announced a big bang fiscal stimulus package a day later to complement Subbarao’s monetary measures. On Saturday I did not know what was coming on Sunday. I am sure RBI was aware of it even though it did not talk about it. It’s another matter that the ministers and bureaucrats in Delhi don’t feel embarrassed talking about money measures which is exclusively RBI’s domain.
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