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SLR cut will not ease liquidity; it will only up bond yields

The Reserve Bank of India's first quarter review of its policy statement for 2012-13 has cast more doubts on the trajectory of both growth and inflation.

The central bank has lowered growth forecast for the full year to 6.5 percent from 7.3 percent while it has upped inflation estimates to 7 percent from 6.5 percent.

In revising the macro forecasts, the RBI has left policy rate and cash reserve ratio unchanged, but cut the statutory liquidity ratio (SLR), which it has reduced by 1 percent to 23 percent from 24 percent.

The question is what has this policy done, either to temper the growth fall or to bring down inflation expectations? Nothing.

In revising the macro forecasts, the RBI has left policy rate and cash reserve ratio unchanged, but cut the statutory liquidity ratio (SLR), which it has reduced by 1 percent to 23 percent from 24 percent. Reuters

Status quo maintained on policy rates leading to interest rates staying at higher levels. The SLR cut will only serve to take up government bond yields and nothing else.

If the RBI was expecting banks to stop buying government bonds at a time when the government is borrowing Rs 15,000 crore on a weekly basis and lend to the economy, it is hugely mistaken.

The higher government bond yields due to the SLR cut will attract more bank money as banks, especially public sector banks, have no interest in lending given their rising non-performing assets (NPA).

The first quarter 2012-13 results of public sector banks have seen their NPAs rise on the back of more loans going bad due to a weakening economy.

The banking aggregates data in the RBI 's weekly statistical supplement shows aggregate deposits rising by an absolute amount of Rs 1,09,270 crore and bank credit growing by Rs 19,650 crores during 30 March-13 June.

Banks are parking money in government bonds as seen by the Rs 1,50,850 crore of investments in government bonds in the same period.

Banks are sitting on SLR levels of over 27 percent, which 300 basis points higher than the regulatory limit of 24 percent. The reason banks are maintaining higher SLR is that the excess SLR gives access to liquidity from the RBI repo window.

Banks are also credit averse as seen by the low credit growth seen during fiscal year to date. The year-on-year credit growth number of 17.7 percent does not paint a true picture of credit demand as it was largely due to a spike in credit growth in the financial year end where banks dress up balance sheets.

The RBI has highlighted the lack of investment demand in its policy report. The aggregate project cost envisaged from the new projects sanctioned financial assistance by banks and financial institutions was Rs 210,000 crore in 2011-12, down from Rs 390,000 crore seen in the previous year.

The RBI has also taken note of the slowdown in growth in total consumption expenditure to 5.4 percent in 2011-12 from 8.5 percent growth seen in to 2010-11.

This was led by a decline in private consumption expenditure growth to 3.2 percent in 2011-12 from 4.8 percent in 2010-11. Slowdown in consumption expenditure suggests a weakening demand in the economy.

The link between the rates and inflation, especially when inflation is more due to weak monsoons and suppressed prices, is tenuous. Even rate hikes by the RBI will not bring down inflation nor will rate cuts raise inflation expectations.

On the liquidity front, the RBI has been buying government bonds with bond purchase amounting to around Rs 80,000 crore in the April-July 2012 period.

The RBI's bond purchases have helped system liquidity as measured by bids for repo in the liquidity adjustment facility to come off to around Rs 50,000 crore from over Rs 1 lakh crore levels.

The central bank has maintained that it will use open market operations to infuse liquidity into the system if necessary. A reduction of SLR will not ease liquidity, as tight system liquidity is not due to banks' buying of government bonds. The government has in fact aided liquidity as it is a net spender.

The stance of the RBI is dramatically opposite to the stance of central bankers around the world. Central banks from the Fed to the ECB are doing what they can to pull their economies from going down a slow growth path but at the same time they are warning their respective governments on fiscal consolidation.

The RBI recognises the threats to growth from a "fiscal cliff" event in the US and a worsening of sovereign bond crisis in the eurozone.

It also recognises the fact that the markets are expecting both the Fed and ECB to act strongly to bring about an easing of the growth and financial stability situation in their economies.

Is the RBI waiting for the effects of the Fed, ECB and other global central banks to filter down to India?