The Reserve Bank of India on Tuesday, 03 June announced its second bi-monthly monetary policy. The central bank kept the benchmark repo rate unchanged. In a slightly surprising move, the RBI cut the Statutory Liquidity Ratio (SLR) by 0.5%. The SLR is the proportion of deposits that banks must park in government bonds. The SLR was reduced from 23% to 22.5%. So does this mean that the RBI has changed its hawkish stance on monetary policy?
The answer would be no. The SLR cut cannot be seen as a precursor to a repo rate cut. It is possible that the RBI has received an assurance that the government is serious about containing the fiscal deficit. This could have prompted the RBI to cut the SLR in anticipation of a more controlled borrowing program. As we had highlighted in yesterday's 5 Minute WrapUp the cycle of lower interest rates will not begin anytime soon. The reason is simple. The RBI governor Raghuram Rajan has been very clear about the RBI's role in combating inflation. He has in the past, gone against popular opinion and hiked rates when the UPA government as well as industry was clamoring for rate cuts. The RBI under Rajan has moved to the international practice of targeting consumer inflation as opposed to wholesale inflation. This has caused a problem for the RBI. India's inflation problem is largely driven by food prices especially the prices of high-protein perishable food items like pulses, meat, eggs milk etc. The government does not store these items. Thus any disruption in supply of these items can cause a spike in food inflation. The Consumer Price Index (CPI) which is composed primarily of food articles continues to remain high due to this reason. The RBI on its part is keeping interest rates high to prevent inflation from becoming more generalized as well as to protect the value of the currency. We believe it has done a commendable job on this front.
It is well known that the new government want to kick start the economic growth engine as soon as possible. Lower interest rates would most certainly help in this regard. However those expecting the RBI governor to lower rates to get in the new government's good books will likely be disappointed. We believe that the government will have to implement a series of measures to open up the economy and boost growth. This will free up the RBI to focus on its primary objectives of containing inflation preserving the value of the Indian rupee.
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