Tight liquidity a concern, SLR can improve it: S Narayan

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Experts are divided on the Reserve Bank of India's (RBI) stance on the credit policy today. Some feel that the central bank is likely to cut cash reserve ratio (CRR) but there are many who still believe that it is going to maintain a status quo.

S Narayan, Former Finance Secretary is confident that a CRR cut is unlikely even though liquidity is a concern. In an interview to CNBC-TV18, he said that SLR cut is a good option to improve liquidity and there can be a CRR cut only if RBI focuses on growth over inflation.

Adding that the economic review clearly indicates RBI's dilemma, he notes that 25 bps CRR cut is not meaningful to address liquidity.

Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.

Q: Do you think a CRR is coming or is there no sense of moving ahead with a CRR cut today?

A: I think if you look at the RBI report which came out yesterday you can see the dilemma the RBI is in. On one side, they are concerned about core inflation remaining high, that food inflation, which has come down, may not last for very long time. They feel that it has fallen only because the winter vegetable crop has come in and therefore food inflation may start ramping itself up in summer. On the other side, they are deeply concerned about the fact that capital formation has been low and new investments have taken a very low level during 2011 and that they are having to push the growth rate downwards to about 7%. So you can see the kind of dilemma they are in.

But there are two indications in the report which may give us an opportunity to look at their mind. One is that they are concerned that liquidity is low, that means that further lending and further credit expansion is getting affected due to liquidity. So some liquidity enhancement is perhaps in their mind. Will they cut CRR? I am not sure that they will. But increasing the liquidity in the market maybe an opportunity that they would consider at this stage.

Q: There are some who believe that given that they are going ahead aggressively with OMOs, maybe they will not tinker with the CRR but do something on the SLR to release liquidity into the system. Do you think that's likely?

A: I think that is a good option for them. If you look back at the Reserve Bank's policy over the last year and half, it is possible to say that perhaps instead of going about it in such marginal steps of 25 bps at a time, if they had calibrated larger increases at more discrete period perhaps they would have got the effect of monetary control much better in a quicker period of time; but of course this is in retrospect.

So if this is a learning process, then perhaps it makes sense for them to wait a while and then make the drop of monetary easing more significant because 25 bps easing at this point of time may not be big enough for investors to start rolling. Therefore, I would argue that perhaps infusion of liquidity through SLR is perhaps better and more feasible option at this particular point in time.

Q: Would you expect to hear on how soon they will start rate cuts, any guidance or any set down in terms of a time line on how fast and how much they want to move this year given how much growth has faltered by?

A: I think they would certainly reiterate what they said earlier that the time for rate increases is over and they need to push through on the growth agenda. But I don't think they need to or should set a time line; they should wait and watch and see how commodity prices, what is happening externally and what is happening actually to growth numbers and revenue numbers in another months time before they announce a decision.

I think it would be fairly prudent for the bank to set out a strategy into the public agenda for the future. I think they would just say that time for increases is over.

Q: The macroeconomic report did take cognizance of the fact that forecasters have cut down GDP targets quite significantly. How much do you think the RBI will come off on that accord?

A: They are looking at now close to 7%. I think given the fact that agriculture has performed fairly satisfactory during this year, I think 7% would be a fairly reasonable actual number. I would still expect Reserve Bank being prudent to talk of the other plus side of 7% rather than the minus side of 7%, because talking of minus side of 7% would cause a kind of a negative sentiment in the market and the economy and they would like to avoid that.

Q: Since it's unable to cut the repo rate this time, could it signal that its coming through a CRR cut?

A: Certainly if the bank decides to say that growth is much more important and that inflation can be controlled as we go along, I think you will see the CRR cut coming. But I do see that the media as well experts have by and large predicted that this is unlikely today, that it maybe likely only in the next time. But again I go back to point that a CRR cut of 25 bps, I don't know how much of an effect it should make for capital investment given all the other negativities associated with governance issues, reform issues, with fiscal policy issues and fiscal deficit issues. So I think the Reserve Bank would be well cognizant that all these issues cannot be addressed by a CRR cut.

I mean from policy point of view, it would not make significant sense for the Reserve Bank to wait for the next round; by then at least budget expectations would be in if not the budget itself. There could be two prong approach, one from the government side on the fiscal side, the other from the monetary side and then you see a real push to growth in 2012 and that would be a kind of a multiplier signal which should take this economy forward in 2012. I would call that a better strategy than to do a small percentage cut now.