RBI's Monetary Policy
Mid-Quarter Review
of December 2010
Rama Krishna Vadlamudi, HYDERABAD
December 17, 2010
(For a reader-friendly PDF version, just click: www.scribd.com/doc/45486596)
Central Bankers around the world would try to move smoothly along with the markets or they expect markets move according to their (Central Bankers) wishes. This seems to be happening of late in India too. The intentions of the Reserve Bank of India seem to be to take the markets in lockstep with itself.
As expected by the markets, the Reserve Bank of India – in its mid-quarter review of the Monetary Policy announced on December 16, 2010 – has kept both the Repo and Reverse Repo rates unchanged. This is as indicated by RBI in its Second Quarter Review of November 2010.
However, the RBI has taken certain measures to boost liquidity in the Banking system. Banks by statute are required to invest a minimum of 25 per cent of their deposits in Government Bonds/Securities. Now, the Statutory Liquidity Ratio (SLR) has been “permanently reduced” to 24 per cent from 25 per cent. In addition, RBI will buy back Government Securities from banks to an extent of Rs 48,000 crore in the next one month. These two measures are expected to ease the liquidity crunch being faced by banks due to sluggish growth in bank deposits, low government spending and others.
Let us examine the Monetary Policy Review decisions and their implications.
Monetary Measures: There are no monetary measures:
1) There is no change in LAF-Repo Rate of 6.25 per cent
2) There is no change in LAF-Reverse Repo Rate of 5.25 per cent
3) The Cash Reserve Ratio (CRR) is kept unchanged at 6.00 %
4) Bank Rate has been retained at 6.00 %
5) Saving Bank rate has been kept unchanged at 3.50 %
Liquidity Measures undertaken by RBI on December 16, 2010:
However, the RBI has taken certain measures to boost liquidity in the banking system. Of late, commercial banks have been borrowing on an average more than Rs one lakh crore daily through the Reverse Repo window of the Liquidity Adjustment Facility (LAF) of the RBI. To alleviate the misery of commercial banks, the RBI has cut (it calls this cut as “permanent reduction” whatever that means) Statutory Liquidity Ratio (SLR) by 100 basis points to 24 per cent. This may not immediately give any relief to banks as RBI has already been temporarily allowing banks till January 28, 2011 to go below SLR up to 23 per cent without any penalty being suffered by them.
Another measure being undertaken by RBI is to buy back Government Securities to the tune of Rs 48,000 crore from banks in the next one month through open market operations (OMO). Banks will sell Government Bonds in their books to RBI and get money in return from RBI. This will put more money in the hands of several banks.
Impact of RBI’s liquidity measures on Markets:
The main impact of RBI’s liquidity measures will be on bond markets. The short-term interest rates will cool down reflecting in T-Bill rates, call money market, commercial deposit and commercial paper rates. Even long-term yields may soften due to the buy back programme of the RBI in Government Bonds. Banks which have, of late, been raising deposit rates steeply too will get great relief.
Why the flip-flop on SLR?
The RBI seems to be revising the SLR too frequently – one year down, one year up and next year down. The following chart illustrates this. In November 2008 following the global financial crisis in the aftermath of the collapse of Lehman Brothers, RBI reduced SLR by 100 basis points to 24 per cent. RBI hiked it again to 25 per cent one year later saying that there was excess liquidity in the banking system. It has now “permanently” reduced SLR to 24 per cent as part of its liquidity measures.
Why has the RBI been revising SLR too frequently? Since the beginning of banking sector reforms in the 1990s, RBI has got a commitment to fulfill – that is to bring down SLR/CRR so that more lendable resources will be available with banks. Of course, there are times when banks keep higher percentage of securities in eligible Government Bonds more than the statutory limit. The excess for some banks would be in the range of 3-10 per cent.
The Government seems to be comfortable with the strong revenue collections and windfall revenues from the 3G Telecom Spectrum auction. So it has, apparently, given a green signal to the RBI to reduce SLR “permanently.” It would be interesting to see how long the so-called “permanent reduction” will hold.
What caused the liquidity crunch:
Banks have been borrowing consistently from the RBI through the LAF-Repo window in the past few months. The average daily borrowing is in excess of Rs one lakh crore which makes RBI uncomfortable.
What caused the liquidity squeeze in the first place?
1. Faster rotation of money lubricates all the components of the economy. However, the money seems to be stuck in Government’s coffers lately. Government of India has been holding money to an extent of more than Rs 80,000 crore in its account with RBI instead of spending it for productive purposes. As the financial year-end draws to a close, the Government may be tempted to spend more.
2. Bank deposit growth has been anemic of late. Savers seem to be attracted to other avenues like – initial public offers or follow-on offers of public sector undertakings in the equity market; postal savings; and fixed deposits and debentures of companies. But now with banks raising their deposit rates by 50 to 150 points across the whole spectrum of time periods, savers may be tempted to invest more in bank deposits.
3. Credit growth driven by stronger growth of the economy is much more than the deposit growth.
4. RBI has been consistently increasing the policy rates and reserve ratios in the past eight to nine months, though it has undertaken certain measures to inject more liquidity in to the system in the past one month.
Notes:
One per cent is equal to 100 basis points (bp)
CRR-Cash Reserve Ratio
LAF-Liquidity Adjustment Facility of the RBI
RBI-Reserve Bank of India
SLR-Statutory Liquidity Ratio
Disclaimer: Views of the author are personal and not necessarily those of the organization he represents
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