RBI policy preview - status quo likely

RBI likely to maintain status quo

In its third quarter review of the Annual Policy Statement on January 27, we expect the Reserve Bank of India (RBI) to keep key policy rates unchanged. Repo rate, cash reserve ratio (CRR), statutory liquidity ratio (SLR), and reverse repo rate are likely to remain unchanged at 5.5%, 5.0%, 24.0%, and 4.0%, respectively.

 

Why not CRR cut?

The beginning of the financial year witnessed a series of hikes in CRR in order to combat surging inflation. However, since October, RBI has cut the CRR by 400bps. Call rates spiked to ~19% with the daily average borrowing amount under the repo averaging ~INR 492 bn in October, inducing RBI to turn the interest rate cycle dramatically.

 

The CRR cuts since October have infused ~INR 1600bn. As a result, currently the liquidity in the system is in surplus. Banks are back in the reverse repo mode since December. The average daily amount parked under reverse repo in January so far is ~INR 415 bn and call rates have also calmed down at sub-5 levels since the beginning of the month. Thus, the current liquidity situation does not warrant further reduction in CRR at the moment.

 

Why SLR to remain unchanged?

On September 16, 2008, the RBI, as a temporary and ad hoc measure allowed banks to avail additional liquidity support under the LAF to the extent of up to 1% of their net demand and time liabilities (NDTL). On November 1, the central bank decided to make this reduction permanent. Accordingly, the SLR was reduced to 24% of NDTL with effect from the fortnight beginning November 8, 2008. Also, RBI has allowed banks (on ad hoc basis) to avail liquidity support under the LAF through relaxation in the maintenance of SLR to the extent of up to 1.5% of their NDTL exclusively for meeting funding requirements of NBFCs and MFs. RBI had also introduced a special refinance facility where in banks were provided refinance facility equivalent to up to 1.0% of their NDTL.

 

We believe the scope for a further cut in SLR is limited at the moment. Government's borrowings so far stand at INR 840 bn against forecasts of INR 390 bn during H2FY09. As this additional borrowing is also scheduled to get over by February 20, there is chance of further borrowings by the government during the remaining part of FY09. A cut in the SLR will lead to a lower demand for government securities, posing difficulties for sailing through of the large government borrowing programme. Moreover, as banks are currently parking their excess funds with the RBI reverse repo, a cut in SLR will not necessarily improve credit disbursal by banks either.

 

Why repo and reverse repo likely to remain unchanged?

In recent months RBI has significantly eased repo and reverse repo rates, possibly front-loading most of the cuts. Repo and reverse repo have been cut aggressively by 350bps and 200bps respectively since October. The government had adopted moral suasion, asking banks to reduce lending rates further. However, the entire impact of the policy rate cut has not yet been completely passed by banks . The prime lending rate has been reduced by only 150bps to 12.5%. At this stage, RBI is thus likely to go slow in slashing interest rates further before banks pass on benefits to borrowers. The central bank and the government will continue with their moral suasion to induce banks to reduce lending rates.

 

However, we do not rule out the possibility of another 50bps cut in policy rates by the April round of monetary policy, primarily to boost sentiments.

 

RBI would like the current large reverse repo balance to reduce and channelize funds to credit. However, capping reverse repo is not likely to be the preferred option as its previous attempt (in 2007) to do so had led to a drastic crash in call rates and uncertainty in the market.

 

Policy stance likely to retain flexibility

During the previous policy, RBI's stance was to strive to balance financial and price stability with growth. With inflation and inflationary expectations coming under check, the central bank has adjusted its policy stance from demand management to arresting the moderation in growth. In particular, its aim is to augment domestic and forex liquidity and ensure that credit continues to flow to productive sectors of the economy.

 

RBI is likely to maintain its stance of prioritising growth with a significant slowdown in real activities and inflation returning to the comfort zone. It will keep its options open for reacting to international and domestic developments swiftly and on a continuous basis.