Monetary policy in reverse gear; too early, too fast:CRISIL
CRISIL Research has come out with its report on RBI's monetary policy review. According to the research firm, liquidity is expected to remain tight as the government is likely to borrow about Rs 150-180 billion from the market on a weekly basis.
April 18, 2012 / 13:51 IST
CRISIL Research has come out with its report on RBI's monetary policy review. According to the research firm, liquidity is expected to remain tight as the government is likely to borrow about Rs 150-180 billion from the market on a weekly basis.
In a surprise move, the Reserve Bank of India (RBI) reduced the repo rate by 50 basis points to 8.0 per cent in its annual monetary policy review today. Given the upside risks to inflation, such a sharp reduction in repo rate has come sooner than desired. The lowering of interest rate may sound like good news in the scenario of fledgling growth, but we believe, the rate cut by itself may not be enough to stimulate investment and GDP growth. The investment slowdown in the country can largely be attributed to policy bottlenecks rather than high interest rates. Hence, for growth to revive, the investment climate, supported by appropriate policy reforms, will have to improve.The RBI has been facing a tough situation over the past few months. Despite two years of interest rate hikes, inflation has still not been brought under control; growth, however, has fallen sharply. The economy is now wedged between sub 7 per cent growth and 7 per cent headline inflation. In addition, six consecutive years of high inflation has heightened fears that the normal level of inflation has risen beyond the RBI’s stated tolerance limit of around 4 to 4.5 per cent. Slowing growth and some moderation in inflation have prompted the central bank to shift its priorities from inflation control to lifting growth. There seems to be greater tolerance for higher inflation, as indicated by the RBI’s decision to cut rates despite the year end guidance of WPI inflation at 6.5 per cent. But if inflationary pressures resurface, the RBI will be left with little room to cut rates further. In that case, rate cut could turn out to be the last one in this yearHighlights of the policy- Repo rate reduced by 50 basis points (bps) to 8.0 per cent. Reverse repo rate and Marginal Standing Facility (MSF) rate at 100 bps below and above the repo rate, respectively
- Borrowing limit of banks under MSF raised from 1 to 2 per cent of their outstanding net demand and time liabilities (NDTL)
- The cash reserve ratio (CRR) retained at 4.75 per cent of NDTL of scheduled banks
- The RBI projects real GDP growth for 2012-13 at 7.3 per cent on the assumption of a normal monsoon
- The RBI projects the wholesale price index (WPI) inflation for end-March 2013 at 6.5 per cent
- Money supply growth is projected at 15.0 per cent in 2012-13, while growth in non-food credit and aggregate deposits is projected at 17.0 and 16.0 per cent, respectively
- Final guidelines on Basel III implementation to be announced by end-April 2012
- Banks to reduce their regulatory exposure ceiling to NBFCs involved in lending against gold
- Foreclosure / prepayment charges on floating rate home loans abolished
- Draft guidelines on the regulatory framework for NBFCs to be announced by end-June 2012
- Final guidelines on securitisation transactions to be issued by end-April 2012
- The RBI to set up a working group to assess the feasibility of introducing more long-term fixed interest rate loan products by banks
- Banks advised to offer ‘basic savings bank deposit account’ with certain minimum common facilities
- Initiation of allotment of unique customer identification code (UCIC) to all the bank customers
Liquidity to remain tight- The banking system saw sharp liquidity tightness in the end of 2011-12. Liquidity remained strained since the third quarter of 2011-12, but its extent escalated in the fourth quarter. The last fortnight of fiscal 2012-13 saw average LAF volumes rise to Rs 1.5 trillion. This translated to a liquidity deficit of around 2.3 per cent of NDTL, which was much higher than RBI’s comfort level of ± 1 per cent of NDTL. Call rates treaded above the MSF rate on several occasions, indicating acute tightness in liquidity.
- Both, structural and frictional factors were responsible for the increase in liquidity deficit. The structural element was largely driven by higher government borrowing, RBI foreign exchange intervention and an increasing divergence between credit and deposit growth. Clearly, demand for funds far exceeded the available supply.
- Higher government cash balances with RBI, and the government’s resort to ways and means advances (WMA) and overdraft facility acted as frictional factors that tightened liquidity on an interim basis. To address the frictional liquidity deficit situation, the RBI cut cash reserve ratio (CRR) twice in the fourth quarter of 2011-12, which released Rs 800 billion into the system. Additionally, it also undertook significant OMOs in the fourth quarter.
- On the demand-side, the huge government borrowing continues to act as a strong factor, aggravating liquidity tightness. As per the 2012-13 borrowing calendar, the government will be raising Rs 3.7 trillion in the first half, as compared to Rs 2.5 trillion in the same period of 2011-12.
- Liquidity, however, appeared to ease in the fortnight ending April 13, 2012, as average LAF volumes fell to Rs 820 billion (about -1.3 per cent of NDTL). This is primarily due to the waning of some of the frictional liquidity factors (such as government spending) and a sudden jump in deposit growth to 17.1 per cent as of the fortnight ending March 31, 2012, in comparison with 13.4 per cent growth in the previous fortnight.
- Going forward, liquidity is expected to remain tight as the government is likely to borrow about Rs 150-180 billion from the market on a weekly basis. This amount is further inflated if we add the borrowings of state governments. There will however, be some respite with banks now being allowed to borrow higher under the MSF window.
Disclaimer: CRISIL Limited has taken due care and caution in preparing this Report. Information has been obtained by CRISIL from sources, which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. CRISIL Limited has no financial liability whatsoever to the subscribers / users / transmitters / distributors of this Report. The Centre for Economic Research, CRISIL (C-CER) operates independently of and does not have access to information obtained by CRISIL's Ratings Division, which may in its regular operations obtain information of a confidential nature that is not available to C-CER. No part of this Report may be published / reproduced in any form without CRISIL's prior written approval.The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.To read the full report click on the attachment 
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