Money & Banking

Rajan likely to maintain status quo on rates

NS Vageesh Mumbai | Updated on April 06, 2015

Fears of inflation creeping up and weak policy transmission may stay Governor’s hand



RBI Governor Raghuram Rajan will likely play it safe and keep the benchmark interest rate (repo rate) unchanged at 7.5 per cent in his policy announcement tomorrow. He has already cut this rate twice by 25 basis points each outside his regular policy cycle during this calendar year.

At the time when he cut rates last, he had said monetary policy should be ‘anticipatory’ once all the data supporting the stance is in. Since then, inflation has reared up slightly, with CPI in February at 5.37 per cent.

Although this is comfortably below the January 2016 target of 6 per cent, the likelihood of a further slight increase in the next couple of months consequent to un-seasonal rains and their impact on food prices, may contribute to staying the Governor’s hand this time.

The other factor to keep in mind is the weak policy transmission with the earlier two cuts having little impact on banks. Just five banks have cut rates (with two banks doing it only last week) and most of the big banks have kept rates unchanged.

Although bond markets have factored the changes and are today at least one percentage point lower compared to the same time last year, base rates of banks remained by and large unchanged. Banks that are under pressure from shrinking margins chose not to further trouble themselves by reducing rates at the end of the last fiscal.

Credit growth has been sluggish in the last fiscal. At a little over 9 per cent growth as of mid-March, this is the lowest growth seen in more than a decade. Even if one accounts for some surge usually seen in the last fortnight (window dressing), the growth is unlikely to be high.

And, traditionally, the first quarter of the new fiscal does not see much credit growth at all. It is, therefore, a moot point whether a cut in rates will make any immediate difference to corporates. At the same time, the RBI will have to keep in mind that the US Fed is likely to start increasing rates in the second quarter of the new fiscal.

Other top central banks are also currently on a monetary easing path. The divergence in interest rates, if it persists, could see more capital flows coming in and add to the RBI’s challenges. Another cut may therefore happen, although not this time.

Room to cut SLR

Given that the decks are being cleared for an independent public debt management agency to take over the role of Government’s debt manager, it is likely that the RBI will have soon some room for cutting the statutory liquidity ratio (SLR), currently fixed at 21.5 per cent of demand and time liabilities.

The RBI could possibly use the opportunity to begin initiating a deeper cut in SLR. There has been a chorus of demand from some banks (including, notably, the SBI chairman) asking for a cut in cash reserve ratio (CRR), currently at 4 per cent.

Considering that there is no pressing liquidity problem nor is there credit offtake, a cut in CRR may not happen. Some economists however feel that some flexibility may be provided in the level of CRR balances that need to be maintained by banks on a daily basis.

This had been increased to 95 per cent in the wake of the problems faced by the rupee in late 2013. That may be eased a bit given relatively stable conditions on the currency front.

Published on April 06, 2015

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