Will RBI credit policy reduce CRR by 25 bps?

Saikat Das
moneycontrol.com

The Reserve Bank of India (RBI) is unlikely to reduce the policy (repo) rate in its mid quarter monetary policy to be announced on June 17. The depreciating rupee would be the key trigger behind such action. The fear of imported inflation may resist the central bank from taking any dovish stance.

Repo is the rate at which banks borrow from the RBI though a daily window, called Liquidity Adjustment Facility (LAF) in banking parlance. Repo stands at 7.25 percent.

Also read: Here's how latest bank credit grew in May 17 fortnight

RBI to pause...

"In view of depreciating rupee, it is most likely that RBI will not cut the policy rate in the June mid quarter policy," Ashok Gautam, Sr VP & head, global market & treasury at Axis Bank.

"A falling rupee brings in imported inflation along with it. However, RBI is expected to slash the policy rate by 50 – 75 basis points in 2013-14. Any improvement in current account deficit and the rate of inflation will be key trigger for the central bank to reduce rate. This is going to take some time. Also, we will have to see if the steps taken to curtail gold import have the desired effect," he said.

Since the beginning of 2013, RBI has slashed repo rate by 75 and cut cash reserve ratio (CRR) by 25 bps. CRR is the portion of total deposits that banks are mandated to keep with the RBI. Currently, it stands at 4 percent.

Rupee - inflation dynamics

The Indian rupee had tumbled 7 percent against the greenback in May while it hit all record high at 58.98/USD on June 11. RBI had to intervene to halt rupee's slide. However, other Asian currencies too fell on the US dollar strengthening.

When the rupee sinks, it hurts imports whose import bill shoots up. Back home, they finally pass on the cost to their consumers. Hence, it fuels inflationary pressure.

In April, the wholesale price index (WPI) inflation dropped to a three-year low of 4.89 percent. However, retail or consumer price index (CPI) inflation stood at 9.30 percent in May as against 9.39 percent in April.

Weighing current account deficit on RBI policy

"The central bank is likely to be back with its juggling act," Radhika Rao, Economist, Group Research at DBS Singapore said in an email reply.

"Just as the WPI inflation is decelerating, the CPI inflation holds above 9 percent and renewed rupee depreciation pressures threaten to complicate the inflation-current account dynamics. Policymakers are also cognizant that the anticipated improvement in current account deficit (CAD) is largely driven by external drivers and weak investment appetite, both of which are not desirable."

DBS expects 100 bps cuts in the policy rate this year, of which 75 bps have already been delivered. The remaining 25 bps may take effect before September as and when the inflation and current account trajectory evolve.

Must read:  RBI plans to revive stressed loan market for banks, ARCs

Gold and CAD

"Substantial gold imports would weigh upon the current account deficit in Q1FY14, the financing of which is a concern in light of the bouts of FII outflows in the ongoing quarter. Accordingly, we expect the RBI to refrain from further easing in the June policy review, despite the weakness in industrial growth," said Naresh Takkar, MD & CEO at ICRA, a rating agency.

Last week the government had increased import duty on gold to 8 percent, the second such hike within two quarters. The monthly gold imports stood at around 150 ton on an average between April and May this year as against 70 ton recorded in 2012-13. However, the government recently hinted at falling gold imports in the first fortnight of June.

India's CAD hit an all-time high of 6.7 percent of GDP in October-December. CAD is generally defined as imports in excess of exports. RBI governor hinted that it would be close to 5 percent in January – March quarter.

Policy transmission

Meanwhile, banks have not decreased rates in line with the policy rate cuts. Banks, according to experts, are likely to transmit policy actions with 3-6 months lag. Recently, the finance minister, P Chidambaram urged lenders to cut rates citing that since 2012 the RBI cut repo rate by 125 basis points but commercial banks have reduced their (base) rates only by 30 bps.

According to Gautam, the liquidity situation needs to improve which will be reflected when the operative policy rate starts to shift from repo to reverse repo. When liquidity eases, lenders will have enough room to cut rates.

A shift from repo to reverse repo means a surplus balance in LAF. This suggests, banks are parking their excess funds with the reverse repo window and comfortable with the liquidity situation.

CRR cut expectation

However, a 25 bps cut in CRR cannot be ruled out. According to Bank of America Merrill Lynch (BofA-ML) note, this move is likely to balance growth and rupee concerns.

"We continue to expect the RBI's CRR cuts/OMOs to push up deposit growth to 14-15 percent levels from the current 13 percent. High lending rates have expectedly pulled down loan demand to 14% levels already," BofA-ML said.

saikat.das@network18online.com