RBI holds rate but frees up more cash

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Monetary policy focus remains disinflation

RBI holds rate but frees up more cash
The Reserve Bank of India (RBI), in its third bi-monthly policy on Tuesday, continued its fight against inflation by keeping the repo rate unchanged at 8 per cent, as widely expected. However, to provide liquidity to banks to lend to productive sectors, it reduced the statutory liquidity ratio (SLR) by 50 basis points to 22 per cent.

In line with this second consecutive cut in SLR, RBI reduced the proportion of SLR securities allowed to be held-to-maturity (HTM) by ba­nks by 50 basis points to 24 per cent of a bank’s net demand and time liabilities (ND­TL). SLR re­fers to banks’ mi­nimum bond hol­ding requirement.

The RBI shifted the target for consumer price index (CPI) inflation to 6 per cent by January 2016 from 8 per cent in January 2015, making a repo rate cut this year doubtful.

Although a cut in SLR is expected to provide roughly Rs 40,000 crore growth-supportive liquidity to the system, it would not trigger an interest rate cut, warn bankers.

Home loan borrowers and companies will have to wait for now to see their equated monthly installments (EMIs) falling.

Accordingly, the repo rate will continue to stand at 8 per cent, the reverse repo at 7 per cent and the cash reserve ratio at 4 per cent. The bank rate would remain at 9 per cent. Speaking to the media, RBI governor Raghuram Rajan said he would not hold interest rates high any longer than is necessary and if disinflation proceeds as warranted, there would eventually be room to cut rates.

“I want to emphasise that the RBI in no way will hold rates high any longer than necessary. There is a path (anti-inflation) we are trying to achieve and we want to achieve that path. We are not against growth but we do think that growth would be most benefited if we disinflate the economy and we don’t have to fight this fight again. Let’s fight the anti-inflation fight once and let’s win and that would create the best conditions for sustainable growth. The government that has a long-term horizon in mind given that it just had elections is on the same page,” he said.

Although consumer price index (CPI) after remaining in the 8-9 per cent band for five straight months dropped to 7.31 per cent in June 2014, its lowest level in the new data series beginning 2010, the RBI said that the risks to achieving the target of sub-8 per cent CPI inflation by January 2015 remained even if they had abated since the last credit policy in June.

The policy statement said that the upside risks to retail inflation was in the form of pass-through of administered price increases, continuing uncertainty over monsoon conditions and their impact on food production, possibly higher oil prices stemming from geo-political concerns and exchange rate movement, and strengthening growth in the face of continuing supply constraints. Accordingly, the upside risks to the target of ensuring CPI inflation at or below 8 per cent by January 2015 remain, although overall risks are more balanced than in June. It is, therefore, appropriate to continue maintaining a vigilant monetary policy stance as in June, while leaving the policy rate unchanged, said the RBI. “Achieving this target will be a tough challenge as disinflation will have to be sustained over the medium term, especially when GDP growth and demand is picking up, said a Crisil report.

Rajan, who has for the third time in a row kept the rate unchanged, hinted at more SLR cuts in the future in tandem with the government actions on the fiscal deficit front to help banks plan for the long-term. The RBI categorised the HTM reductions as “resource mobilising measures” for the private sector as and when economic conditions may require credit demand.

Commenting on the policy, KR Kamath, chairman and managing director at Punjab National Bank said, “I think the RBI’s intention is clear, that the SLR cut is not to bring down lending rates but to provide sufficient liquidity to banks to meet the increase in credit demand as economic growth picks up pace and at the same time freeing up resources to meet the international liquidity coverage ratio norms.”

SBI chairman Arundhati Bhattacharya said, “The 50 bps cut in SLR is expected to provide roughly Rs 40,000 crore growth-supportive liquidity to the system and the move is not intended to trigger an interest rate cut.”

“The HTM ceiling is being brought down by 50 basis points to 24 per cent of NDTL. As all the major banks are holding less than 24 per cent in HTM, there will not be any immediate impact. The six per cent retail inflation target looks challenging (as 6 per cent is the upper confidence level of the median RBI target at 4 per cent), and to that extent, the RBI will hold rates at least till that time it is not breached. Banks will thus need to factor possibly a prolonged policy pause in their decision making,” added Bhattacharya.

According to Vidya Bala, head of mutual funds research at FundsIndia, “We have not so far seen banks increase their lending to industries as a result of SLR cuts. As of May 2014, credit deployment by banks to industries was 12.8 per cent year on year, lower than the 15.3 per cent seen a year ago. This suggests that while the SLR cuts provide room for banks to lend, banks would wait for deployment than act immediately.”

The RBI said that the GDP growth rate of 5.5 per cent was achievable but contingent on many factors. These included a favourable policy environment for investments, revival of stalled projects, government sticking to fiscal targets, crude prices moderating and an uptick in the export market. “On the other hand, if risks relating to global recovery, the monsoon and geo-political tensions intensify, the balance of risks could tilt to the downside,” the RBI said in the policy statement.

A statement from the finance ministry said that on its part, the government remains committed to the path of fiscal consolidation and reviving the investment cycle that will help bring down inflation and pick-up growth further. The ministry further states that going forward, the RBI should examine the liquidity situation, inflation and growth in setting policy rates.

The bond markets remained somewhat nervous post release of the policy statement. The 8.4 per cent 2024 G-Sec yields rose 0.78 per cent, perhaps sensing some hawkish tones. That said, rates are likely to remain in a range of 20-30 basis points from the current 8.55 per cent, said Bala.


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