6 RBI Monetary Policy Review

w w w. f i n a n c i a l e x p re s s . c o m

WEDNESDAY l AUGUST 1 l 2012

The SLR cut will make credit available to retail and corporate borrowers. RBI has sought to anchor inflationary hopes while ensuring liquidity for credit availability
Chanda Kochhar, CEO & MD, ICICI Bank

The hike in exporters credit refinance in the previous RBI policy announcement added R6,500 crore worth of liquidity for SBI. This SLR cut will free up R10,000 crore
Pratip Chaudhuri, chairman, State Bank of India

Some states are seeing a monsoon deficit, but its too soon to judge the impact on credit growth. We expect credit growth to remain at the estimated levels of 17-18%
MD Mallya, CMD, Bank of Baroda

Inflation is high. If the interest rate is not attractive to the depositor, hell look at other avenues. If I cant reduce deposit rates, Ill have to hold on to my lending rates
KR Kamath, CMD, Punjab National Bank

IN A NUTSHELL

TRACKING CRR

Bond street jarred by SLR cut

Traders say even as yields could harden, hope of OMOs could lend some support in coming weeks
Aparna Iyer Mumbai, July 31: If the absence of a cut in policy rates was not bad enough, the bond market was hit by a cut of 100 basis points in the statutory liquidity ratio (SLR) by the Reserve Bank of India (RBI) on Tuesday . The RBI slashed the portion of deposits that banks are required to invest in government bonds to 23% from 24% earlier. The cut will take effect from August 11. The SLR has been cut after a gap of two years. The yield on the benchmark 10-year bond surged eight basis points after the policy outcome. Yields had already risen over 10 basis points over the last one week as expectations of rate cuts had receded. The central bank kept policyratesandthecashreserve ratio (CRR) unchanged at its firstquarterreviewof monetary policy on Tuesday Most . traders expect the 10-year bond to hit 8.5% in the next two months, given the incessantsupplyof bondsthrough auctions. The government is scheduledtoborrowR1,21,000crore through bond auctions over the next eight weeks.While bond traders said that a devolvement at the auctions may not happen, the SLR cut will reduce demand and increase cutoff yields. I, however, don't see deSLRcutonliquidityandeven on bond yields as many hold bonds over and above the mandated limit. The SLR cut looks more cosmeticinnature.Atthecurrent juncture, it does not look effective. The system, as a whole, has excess SLR, said Pradeep Madhav, managing director, STCI Primary Dealership. Madhav expects the 10-year yield to be in the 8.208.30% range despite the SLR cut as banks hold in excess of the regulatory requirement. Somemarketparticipants hoped that even though liquidity conditions may not warrant open market operations, the central bank may announce OMOs given the surge in bond yields after the SLR cut. Moreover, the central bank needs to pump in cash into banks to prod them into lending to the private sector, dealers said. mere cut in SLR will not A push banks to lend to companies instead of the government,saidaseniorbondtrader at a public sector bank. Bond traders said that even as bond yields could harden, the hope of OMOs to come could lend some support in the comingweeks.Therefore,manydo not expect a persistent rise in bondyields. OMOs would be needed because there is huge supply expected.SomepainfromSLR cut could be absorbed by OMOs, said P Mukherjee, headof treasuryatAxisBank.

POLICY MEASURES

ReporRate kept unchanged at 8% Reverse repo stays at 7% Cash reserve ratio stays at 4.5% Statutory liquidity ratio cut to 23% of deposits from 24%, effective August 11 Lowering policy rates now would only aggravate inflationary impulses without necessarily stimulating growth Primary focus of monetary policy remains controlling inflation Decline in non-food manufactured inflation not commensurate with growth moderation RBI says will respond to liquidity pressures, including by way of open market operations Baseline GDP growth forecast for 2012-13 cut to 6.5% from 7.3% Baseline Wholesale Price Index inflation projection for March 2013 raised to 7% from 6.5% Conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4-4.5% The challenge before the monetary policy committee is to maintain its priority of containing inflation and lowering inflation expectations Deficient and uneven monsoon performance so far will have an adverse impact on food inflation Going forward, further pressure on non-food manufactured products inflation cannot be ruled out Outlook for food and commodity prices, especially crude oil, has turned uncertain The reversal in crude oil prices in recent weeks may add to domestic inflationary pressure Input price pressures due to exchange rate movements and infrastructure bottlenecks in coal, minerals and power may push up non-food manufactured products inflation While growth has slowed down significantly, inflation remains well above the comfort zone Wage inflation in rural and urban areas remains relatively high Large twin deficits pose significant risks to macroeconomic stability Risks of potentially large negative spillovers from the US and euro, have increased External risks to the outlook for the Indian economy are intensifying If the rainfall deficiency persists, agricultural production could be adversely impacted Need immediate action on fuel, fertiliser subsidies to meet the target of restricting the subsidy Data for industrial activity in Apr-May suggests that industrial production, despite some recovery, remains weak. M3 growth projection for 2012-13 has been retained at 15% and the growth in non-food credit of scheduled commercial banks at 17%.

POLICY STANCE

volvements in the upcoming G-sec auctions in view of the relatively lower levels of Gsec yields as well as the ensuing expectations of OMO auctions, said Nirav Dalal, president & managing direc-

tor of debt capital markets at YES Bank. Dalal said that the 10-year yieldcouldhit8.50%andmay move in the 8.25-8.50% band. Most bank treasurers are unsure of the impact of the

FORECASTS

No implicit message to govt via SLR cut, says Subbarao

feBureau Mumbai,July31:RBIgovernor Duvvuri Subbarao on Tuesday dismissed the view that the central bank was tryingtosenda messageof intolerance towards higher fiscal deficit and government borrowings through the cut in SLR. The move was not driven by the need to shift the banks portfolio from the government to the private sector,Subbaraosaid. Speaking to reporters at a conferenceafterthereleaseof the first-quarter review of monetary policy the RBI gov, ernor said there was indeed scope to cut policy rates, but said it was difficult to give a timeframe. Well, I see a scope, but I cannot really say when; I cannot even say when it will happen,saidSubbarao.Hepointed out that the growth-inflation dynamics were becoming complex and, therefore, it was not possible tosaywhatexactlywouldtrigger a rate cut. The governor said the RBI's action on rates will depend on not just the inflation projection, but also on the growth outlook and other factors. It would also not hinge only on a fiscal correction, he said. We cannot

SLR cut points to more OMOs, but RBI says no link between the two
AparnaIyer Mumbai, July 31: The SLR cutwillbearfruitonlyoncethe RBIbeginstobuygovernment bonds through open market operations, say bankers. The rationaleof SLRcutisthatRBI wants bank credit to flow into productivesectorsratherthan the government. Unless they infuse cash into the system, thiscutwillnothavemuchimpact,saidthetreasuryheadof aEuropeanbank. However, RBI governor D Subbarao said there is no linkage between the SLR cut and the central bank's OMOs. We said we will manage liquidity through OMOs, but that is not tosuggestthatwewillmanage yields,Subbaraosaid. Subbarao hopes that the SLR cut will reduce banks' reliance on high-cost bulk deposits, beside increasing their access to collateralised liquidity However, RK Bakshi, exec. utivedirectoratBankof Baroda, said unless OMOs are conducted, deposit rates are unlikelytocomedown. RBI deputy governor Subir Gokarn said the SLR cut is not intended to put immediate money into banks' hands. The cut will enable banks to access liquidity as and when they get lendingopportunities. Bankers were noncommittaloveracutintheirbaserates following the SLR cut. The cut is expected to infuse R60,000 croreof liquidityintobanks. SBI chairman Pratip Chaudhuri said retail loans could be priced lower, but didn't elaborate on the base rate. The efficacy of SLR is debat-

INFLATION STANCE

RBI governor D Subbarao (centre), along with deputy governors (left to right) HR Khan, KC Chakrabarty, Anand Sinha and Subir Gokarn, in Mumbai on Tuesday

GROWTH, ECONOMY

characterise that (fiscal correction) as necessary or sufficient.Howweevaluatethatas necessary or sufficient or both will depend on other circumstances. Subbarao said the economy is not in stagflation even though the central bank's growth projection is lower than its inflation outlook. He said the momentum of core inflation was disturbing and suggested that demand pressureswerestillpresent. The governor said the fall in core inflation was not commensurate with the fall in growth rate. He highlighted

worries over inflation, especially with the monsoon playing truant. However, he said thatthesituationwouldnotbe asbadas2009-10whenfoodinflation soared to double digits after a nationwide drought scenario. Subbarao said the the country had enough buffer stock and better management of drought situation, which could prevent a runawayriseinfoodprices. In 2009-10, food inflation surged to as high as 20% with failedmonsoonbeingamajor factor. In May 2012, food inflation was 10.81% Also, the weakmonsoonmaynothavea

big detrimental impact on growth,giventhelowershare of agriculture.Ongrowth,the governorsaidthattheRBIhas deliberately not put a downside or upside bias to the 6.5% projectionunlikeinthepast. Subbarao said fiscal correctionswoulddefinitelygive aboosttoinvestment. While the RBI hopes that bankswillpassonthebenefits of the more freely available liquiditythroughtheSLRcut, Subbarao said that banks must understand the reason for slower deposit growth by interactingmorewithdepositorgroups.

able, considering the excess bondholdingsof thebanksbecauseof highgovernmentborrowing,bankerssaid. Intheory ,anSLRcutresults in banks shedding sovereign securities and lending to corporates.However,thehighgovernment borrowing has resulted in most banks keeping SLRfarinexcessof theregulatorymandate. SLRisaplusforincremental liquidity It would encour. age banks to lend more. But I have doubts of its efficacy right now, said P Mukherjee, headof treasuryatAxisBank.

RBI has hit the mark by shifting focus to inflation management

SAJJID CHINOY
INaweekwhenoneof Indias Olympicshooterssuccessfullyhitthemark,Indiascentral bank must be complimented fordoingthesame. In recent days, markets hadgrudginglyacceptedthat a rate cut was not possible in the current environment and, therefore, there was no great surprise when the RBI held its ground. But for me, therealstorywasthattheRBI simultaneously reduced its FY13 growth forecast to 6.5% and increased its year-end inflationforecastto7%. How is that possible? Shouldnt lower growth result in lower inflation? Or higher inflation be driven by higher growth? On the face of it, it can be explained by the factthatwearepoisedtohave a deficient monsoon, This willconstituteagenuinesupply shock on the economy pushing up food inflation (and, therefore, rural wages), butalsopullingdownagriculturalandheadlinegrowth. However, there is a more fundamental issue at hand: that Indias potential growth has fallen such that even sharply slowing growth over the last four quarters has not created enough slack in the system to quell stubborn inflationarypressures.TheRBI estimates that Indias potential has fallen from 8% to 7.5%.Weworrythatithasfallen even more. How else can youexplainCPIcoreinflation in double digits when growth has been tracking 6% or less forthelastthreequarters? A sharp fall in investment over the last three yearshas deprived the economy of much-needed capacity additionoverthelastfewyears.As a result, capacity constraints are still binding despite growth slowing so sharply with the recent power-grid shutdownonaccountof overdrawing from certain states beingthelatestmanifestation of existing capacity bursting attheseams. But its not all gloom and doom. The experience of the mid-2000swhenIndiagrew at 9% and inflation averaged justabove5%suggeststhat potential can re-accelerate quicklyandsharplyif investment is the key driver of growth. The key question is whatailsinvestment? Blaming it all on interest rates is a red herring. Real rates over the last year averaged exactly what they did in the three years prior to the Lehmancrisiswhenindustry and investment were booming. But the proof of the pudding is in the eating: ask any entrepreneur and he will say that50-75bpsratecutswillnot mean the difference between aviableandunviableproject. Instead, binding constraints on factor inputs (land,labour,power,coal)and risingpolicy ,macroeconomic and regulatory uncertainty have been far more responsible for the investment slowdownoverthelastfewyears.I would, therefore, argue that we dont necessarily need big bangreformsrightnowinthe wake of finite political capital. Instead, we just need currentprojectsonthegroundto reach completion through theremovalof executionand implementation bottlenecks. Andinterestratecutswillnot dothetrick.Further,inflation risks have risen in recent weeks. The deficient monsoon will likely push up food inflation and rural wages. And the more coordinated central bank easing there is across the globe, the greater the pressure on commodity prices and inflation in India. So,RBIneedstobecommended for focusing primarily on inflation-management. The RBI also needs to be commended for cutting SLR. Itmayseemlikeaninnocuous and ad-hoc move. But if its part of a strategy to structurally reduce the SLR, the RBIneedstobelauded.Financial repression has plagued theIndianbankingsystemfor fartoolong,andthesoonerthe RBI unshackles the system, thesoonerthatdepositorswill stop subsiding the government through below-market yieldsontheirborrowingand the greater the incentive for the government to put its fiscalhouseinorder. Like one of Indias Olympic shooters, the RBI seems to have hit the mark. Going forward, their policy suggests the division of labour will be clear. The RBI will focus primarily on containing inflation and inflationexpectations toprotect medium term growth. And it is the government that will havetobeartheonusof jumpstartingnear-termgrowth. The writer is India economist, JP Morgan. The views are his personal