As usual, the Reserve Bank of India (RBI) monetary policy announcements was highly anticipated this time as well. This is because of the central bank's power to ease liquidity costs and pump growth rates. But, for the second time since April 2012, the central bank decided to keep rates unchanged. Under current circumstances the RBI believes that easing policy rates would only stoke inflation, and not necessarily stimulate growth.
The RBI maintained status quo on the policy rate front. It kept the cash reserve ratio (CRR) for banks at 4.75% and the repo rate unchanged at 8%. The rate at which RBI borrows from banks (reverse repo) remains at 7% post the review. This was in line with the general market expectation.
But, there was some liquidity enhancement measures undertaken by the central bank. The RBI cut the statutory liquidity ratio (SLR) of scheduled commercial banks from 24% to 23% of their deposits with effect from mid August. The SLR is the percentage of total deposits that banks need to invest in the government bonds. The reduction will help in the flow of credit through the system. The 1% cut, based on the total deposits in the country will help inject around Rs 620 bn of liquidity into the system. However, credit offtake has been muted, and doesnit seem to be really taking off anytime soon. Thus this liquidity cushion can only be used over a course of time. Although the liquidity conditions have eased significantly in recent times, the RBI felt it was necessary to ensure that such pressures do not constrain flow of credit to productive sectors of the economy. What has also been worrying the RBI is the gap between credit and deposit growth, which could eventually choke credit flow in the system.
A rate cut at this juncture would increase inflationary pressure in the economy rather than propel growth. The RBI expects the below par monsoons this year to have a negative impact on food inflation. In April the RBI had made a baseline projection of Wholesale Price Index (WPI) inflation for March 2013 of 6.5%. However this was assuming a normal monsoon. Headline inflation continues to remain sticky, above 7%, on account of an increase in food prices, input costs, and upward revision in prices of certain administered items such as coal. Now keeping with the current trends, the central bank has raised its WPI inflation forecast to 7% for March 2013. Plus, seeing the deficient monsoon, slowing industrial activity, and weak overseas recovery, the RBI has moderated its GDP growth projections for FY13 to 6.5% from 7.3% earlier.
The primary focus of monetary policy this time was on inflation control in order to secure a sustainable growth path for India over the medium-term. The RBI has upped its inflation guidance and moderated its growth target for the country. This shows that things may not get better any time soon. Overall economic activity remains subdued and credit off take remains muted. The deficient monsoons are currently a major risk factor towards growth and inflation. All in all, we do not see the SLR cut as a masterstroke for tackling the tricky balance of inflation and growth rate.
LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Use of the information herein is at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Before acting on any recommendation, investors should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India. Telephone: 91-22-6143 4055