For the second consecutive time in a row Reserve Bank Governor D Subbarao left the key interest rate unchanged to fight inflation but cut but the statutory liquidity ratio by a percentage point to 23% to increase the flow of credit to industry, and lowered the growth projection for the current fiscal to 6.5 percent.
SLR is the portion of deposits that banks have to maintain in the form of government bonds. Lowering of SLR could bring down market interest rates as it would release close to Rs 55,000 crore into the system. SLR cut provides more leeway to banks to disburse funds to productive sectors effectively, but it may not provide any short-term stimulus to India’s economy. Most analysts see the cut as a half-hearted measure to improve liquidity, and have made it clear that it is not sufficient enough to induce bankers to lower lending rates.
But backing RBI’s move, chairman of the Prime Minister’s Economic Advisory Council C Rangarajan said, the central bank has struck an appropriate balance between the need to contain inflationary pressures and give some incentive for growth.
SLR cut will “maintain liquidity to facilitate smooth flow of credit to productive sectors to support growth,” RBI Subbarao wrote in the review. “In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth. As the multiple constraints to growth are addressed, the Reserve Bank will stand ready to act appropriately.”
“SLR cut is a step in the right direction,” C Rangarajan, chairman PMEAC told CNBC-TV18. He expects SLR cut to be followed by open market operations.
In an OMO, the RBI buys government bonds from banks when liquidity is tight and banks are starved for funds. And when there is excess liquidity in the system, the RBI sells government bonds to banks. He added that the cut in the Statutory Liquidity Ratio (SLR) is in a way injecting more liquidity into the system.” This will prevent to some extent the crowding out of private investment.
Further defending the RBI’s hawkish stand, Rangarajan said the cut in the repo rate would have sent a wrong signal at a time when inflation is running very high.
Even chief economic adviser to the finance ministry Kaushik Basu reiterated that RBI has made the right move by keeping repo rate unchanged. “Lowering of the SLR is a small but very important move,” he said, adding that RBI is tackling liquidity by more open market operations. He, however, was of the opinion that the central bank should look at interest rate cuts in the medium term to incentivise private sector investments.
Stating that inflation may come down to below 7 percent by September, Basu said that India is not facing a problem of stagflation.
The economy is likely to grow below 6 percent in the first half of the 2012/13 fiscal year because of a drought-like situation, Basu added.
Basu said the economy was still strong but admitted that the government has slowed down on policy reforms. He said that suggestions on diesel price reforms and FDI in multi-brand retail are with the finance minister and it is for the government to choose the timing of such reforms.