Governor Raghuram Rajan keeps key policy rates unchanged

Rather than cut key interest rates, the Reserve Bank has released liquidity into the system.

Though price pressures persist, the RBI maintained status quo on key interest rates but slashed the Statutory Liquidity Ratio to spur bank lending and get the sluggish economy moving.

Showing his commitment to boosting the economy, Governor Raghuram Rajan, in the second bi-monthly monetary policy of 2014-15, invoked Abenomics — of Japanese Prime Minister Shinzo Abe — saying growth in the coming quarters will depend on “three arrows” — monetary, fiscal and economic strategies.

Expand bank resources

The 50-basis-point cut in the SLR to 22.5 per cent (from 23 per cent) of bank deposits, starting mid-June, will expand banks’ resource base by about ₹40,000 crore. This amount, currently invested in government securities, could get released for lending purposes.

The SLR cut is also seen as a device to restrain the Government from borrowing from the market. The central bank had last cut the SLR from 24 per cent to 23 per cent on July 31, 2012.

But the contrarian view is that banks may not pare SLR investments as there is hardly any appetite for credit in the system. Thus, banks, barring foreign lenders, have been maintaining high SLR holdings of about 28 per cent of total deposits. According to bankers, anyway the SLR cut will provide relief only in the case of incremental deposits that banks raise.

Predictably, India Inc hailed the central bank’s move to cut SLR, saying it will give banks more room to lend to the corporate sector but said a cut in key rates would have been more propitious for growth.

As much as the SLR cut, this policy is crucial for its dovish stance on inflation. In its policy statement, the RBI said: “If the economy stays on this course (taking retail inflation to 8 per cent by January 2015 and 6 per cent by January 2016), 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.”

With the central bank holding key rates, the interest rate at which banks borrow short-term funds from the RBI (known as the repo rate) stays at 8 per cent. Further, the slice of deposits that they necessarily have to park with the RBI — the cash reserve ratio — remains at 4 per cent of their total deposits.

Calibrated approach: Jaitley

The RBI moves struck a chord with the new Government, with Finance Minister Arun Jaitley describing the status quo as a calibrated approach to strike a balance between growth and inflation. Jaitley said the government on its part will address the problem of price rise by improving supplies. In a statement, he said: “It is a priority for the government to maintain a balance between growth and inflation ... It (RBI) has followed a calibrated approach aimed in the direction of balancing between growth and inflation.”

ECR reduced

Elsewhere, as part of the monetary policy review, the RBI reduced the liquidity provided under the export credit refinance (ECR) facility from 50 per cent of eligible export credit outstanding to 32 per cent with immediate effect. With this, the quantum of cheap funds available for arbitrage when liquidity is tight has been reduced. The refinance is aimed at encouraging banks to provide finance to exporters.

The ECR is repayable on demand or on the expiry of fixed periods not exceeding 180 days. It is available at the repo rate. The draining of liquidity under the ECR has been compensated by the introduction of a special term repo facility amounting to 0.25 per cent of the banking system’s total deposits.

This move is the apex bank’s bid to develop a term structure of interest rates, reflecting the expectations of market participants about future changes in interest rates and their assessment of monetary policy conditions.

(This article was published on June 3, 2014)
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