Curtains for easy monetary policy

Curtains for easy monetary policy
The Economic Times, October 28, 2009, Page 1

No Change In Key Rates, But SLR Increased By 1%

Our Bureau MUMBAI

RBI governor Duvvuri Subbarao on Tuesday ended his soft monetary policyaimed at easing the credit crisis last yearby withdrawing liquidity-boosting measures, becoming the third central banker in the world to do so after Israel and Australia. An increase in lending rates is now imminent next quarter if consumer and asset prices remain high. Benchmark rates were, however, kept unchanged.

Mr Subbarao withdrew a special facility that made funds available from banks to mutual funds and finance companies; made loans to commercial real estate more expensive; forced banks to invest more in government bonds; and asked lenders to set aside more funds for bad loans. The special facility was introduced last year to boost liquidity to financial sector firms after the credit markets froze.

RBI maintained the repurchase rate, or repo ratethe rate at which it provides funds to banksat 4.75%; reverse repo ratethe rate at which it accepts deposits from banksat 3.25%; and the cash reserve ratiothe slice of deposits banks have to mandatorily park with the central bankat 5%.

But the central bank surprised the market in its choice of instruments to announce the exit of an easy money policy. The statutory liquidity ratio (SLR), which prescribes the percentage of deposits that banks are required to invest in government debt, has been raised from 24% to 25%, which Mr Subbarao said was a reversal of an exceptional measure. Last year, at the height of the global credit crisis, RBI had lowered the SLR to ease credit flow to industry.

The apex bank also raised its forecast for inflation as measured by the Wholesale Price Index to 6.5% by March 2010, from 5% earlier, as food prices continue to rise on short supply due to the worst monsoon rains in more than a quarter of a century.

We could see stronger action in the coming quarters, StanChart India CEO Neeraj Swaroop said. RBI will wait for stronger data before taking more aggressive measures, he said.
JPMorgan India chief economist Jahangir Aziz also foresees a sharp rise in lending rates if RBI were to hike interest rates later. The Indian Banks Association (IBA)the lobbying arm of commercial bankssaid it expects interest rates to remain stable for a while.

Despite fiscal policy managers saying they want to ensure that there is a solid rebound in growth before interest rates are hiked, the Centre and Reserve Bank governor have chosen a policy that leads rather than follows the market.

HOLDING TIGHT

A non-event

Not really. Without hiking interest rates, the Guv has done enough to hint that rates will harden in a few months. Lending rules have been tightened and a few fire-fighting measures taken during the October '08 crisis have been withdrawn

Whom will it hurt?

Builders and banks. Loans to builders, particularly those setting up office buildings, malls and multiplexes, will become more expensive. Banks will have to provide more, or set aside a bigger slice of their earnings, for such loans, even if the borrower does not default

So, what happens to loans that have turned sticky

Banks will have to step up their provisioning for bad loans. If a loan outstanding is Rs100 crore, a bank will have to provide a minimum 70% (or, Rs 70 cr). This will impact profits of many big banks. Bankers feel RBI should take a relook at this

Has RBI made things difficult for the consumer

No. Banks are not expected to hike interest rates on home, auto and personal loans immediately. But they may in Jan. That's when RBI may hike CRRthe slice of customer deposit that banks set aside as cash with RBIto reduce surplus money with banks

Then, why's Dalal Street nervous

The market was set for a correction and took the hawkish policy as a trigger. Realty stocks plunged & biggies like SBI and ICICI slipped. Besides higher provisioning , RBI said it will not relax the mark-to-market accounting norm on g-sec holdings of banks. So, banks will have to take m-t-m hits as interest rates rise

Is RBI trying to discipline banks

In a way. Besides new loan rules, it will also outline broad rules on the salaries banks pay to their CEOs and senior managers. While RBI today has the last word on CEO pay, there are no guidelines like the ones applicable for bonus payments

H I G H LI G HTS

Keeps benchmark interest rates unchanged

Hikes SLR by 100 bps to 25%

Retains GDP forecast for FY10 at 6%

Says industrial output may revive in the near term

Cuts money supply growth target a hint that CRR may rise