RBI opts for status quo, but gives rate cut hope

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50 bps cut in SLR unlocks Rs 40,000 cr in system

RBI opts for status quo, but gives rate cut hope
The Reserve Bank of India on Tuesday refrained from any rate action but hinted at a cut in the next policy review if inflation continues to decline.

In the second bimonthly monetary policy review, the first under the Modi regime, the central bank looked rather cautious, but bankers and financial markets read a dovish tone in the fine print.

RBI said it remained committed to keeping the economy on a disinflationary course, taking CPI inflation to 8 per cent by January 2015 and 6 per cent by January 2016.

“If the economy stays on this course, further policy tightening will not be warranted. On the other hand, if disinflation, adjusting for base effects, is faster than currently anticipated, it will provide headroom for an easing of the policy stance,” the RBI statement said.

As an incentive to push growth, governor Raghuram Rajan reduced the proportion of deposits banks are required to park in government securities (SLR or statutory liquidity ratio) by 50 basis points to 22.3 per cent.

This is expected to unlock about Rs 40,000 crore in the system.

Bankers and market analysts said the dovish outlook would eventually herald a softer interest rate regime and spur growth in the economy.

Lenders ruled out any reduction in lending rates, at least in the near future. “There will be no immediate change in interest rates, but the policy is showing consistency in guidance, both for the medium and long term,” said SS Mundra, chairman and managing director of Bank of Baroda.

Indian banks carry excess SLR securities and, hence, the move to cut SLR will have no immediate impact on their cost of funds. SLR is a mandatory reserve requirement that forces banks to invest 22.5 per cent of their deposits and a portion of their loans in government bonds.

With CPI as the policy barometer, RBI thinks interest rates can be brought down if there is an accelerated decline in inflation, Mundra said. “The reduction in SLR is also on the lines of RBI’s stated goal of bringing down bank investment in government securities so that more credit can be diverted for productive use.”

Bond yields ended about 6 to 9 basis points lower on Tuesday from previous day’s. The benchmark 10-year bond ended lower at 8.60 per cent. The rupee continued its losing streak and softened further against the dollar to close at 59.38.

Chanda Kochhar, managing director and CEO of ICICI Bank, the largest private sector lender, described the policy as very ‘balanced’ and ‘pragmatic’.

“The reduction in the SLR is a welcome signal of the commitment to reduce pre-emption of resources over time and create more room for banks to finance growth,” Kochhar said.

The cut in SLR is aimed at encouraging banks to lend more to industry and invest less in government securities. But poor credit growth has forced lenders to invest heavily in government bonds; their exposure stands about 4 to 5 per cent higher than the mandatory requirement, at 28-29 per cent. This means the SLR cut will be of no use if credit demand doesn’t pick up.

The headline inflation increased to 8.6 per cent in April after showing a decline in the first two months of the calendar. Core inflation edged down, but continues to be above 8 per cent.

Accordingly, the cost of funds for banks is expected to remain high in tandem with the rate of inflation, which forces banks to offer higher deposit rates.

Crisil expects the overall cost of funds for banks to remain at elevated levels. “With traction in deposits, supply of funds has improved in the recent past, lowering dependence on borrowings from RBI. Inter-bank money market rates have declined by 75-100 bps in the past nine months. Nevertheless, we expect lending rates to remain high amid concerns over asset quality and an elevated credit-deposit ratio,” the rating agency said.

Indian companies are yet to kick off their capex programmes, which is why credit growth has slowed down to 13.3 per cent year-on-year as of May 16 from 14.7 per cent as on May 17, 2013.

Sluggish investment demand and increased risk aversion due to deterioration in asset quality of domestic lenders, public sector banks in particular, have put the brakes on credit flow from banks, forcing them to divert surplus liquidity into government bonds.

RBI said easing of domestic supply bottlenecks and progress in the implementation of stalled projects should brighten the outlook for both manufacturing and services. The resumption of export growth is a positive development and export prospects should further improve as world trade gathers momentum

“We see stability and a steady policy stance, even as the overall approach of the policy is neutral to dovish,” Shailedra Bhandari, managing director and chief executive officer of ING Vysya Bank, said in a release.


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