Possible steps Raghuram Rajan can take today: What to expect from RBI policy

The Reserve Bank of India (RBI) is set to announce its third bi-monthly monetary policy today.

Of the six times Raghuram Rajan presided over the monetary policies, Rajan increased the key policy rate, repo, thrice by a total of 75 basis points (bps) to 8 percent and opted for status-quo thrice. One bps is one hundredth of a percentage point. Repo is the rate at which the apex bank lends short-term funds to banks.

Today’s policy is unveiled in the backdrop of a visible decline in the inflation rates and early signs of recovery in the growth indicators of Asia’s third largest economy.

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India’s retail inflation has stayed between 9 percent and 10 percent for consecutive nine months until December and above 8 percent in the subsequent months until May, before falling below 8 percent in June. Wholesale price based inflation too fell in June to 5.43 percent.

Trends in wholesale inflation are somewhat irrelevant at this point, because the RBI has officially accepted the central forecast of Urjit Patel panel that projected consumer price index (CPI) inflation down to 8 percent by January 2015 and 6 percent by January 2016.

The economic growth, on the other hand, has remained at sub-5 percent levels in the recent quarters.

As Rajan prepares to unveil his policy prescriptions to cure the twin challenges of still persisting inflation and falling growth, here are the few possible steps that the former international monetary fund chief economist might opt for and their possible impact.

Status-quo in repo rate

A status-quo in the key lending rate is the most likely outcome of today’s policy according to majority of the economists, who argue that the threat of inflation is yet to sustainably ease to the comfort level of the central bank, which will prevent Rajan from cutting rates.

A status quo in policy rate would be a non-event for the financial markets and common man. Banks will wait for more policy cues before taking a call on their interest rates.

A status-quo will support the inflation battle of the central bank, besides helping the rupee retain its stable level. Industries may not be happy with the move as their interest costs will not come down.

25-bps cut in repo rate

A quarter percentage point cut in the repo rate in the backdrop of falling inflation is not ruled out. This will be a pleasant surprise to both the investors and end-consumers of banks as banks might look at passing on the lower costs to the borrowers. This can bring down cost of borrowing for consumers and add to the profitability of companies.

A rate cut may not be good news for the currency market though. Lower interest rates here would prompt the foreign investors pull out money from here that could put pressure on the rupee.

Cut in SLR

Another possibility Rajan might look at is a further reduction in the statutory liquidity ratio (SLR), the portion of money banks need to invest in the government securities and gold. Currently, SLR for banks stands at 22.5 percent, even though the average bond holding of banks is about 28 percent. A cut in SLR will not help much since banks will not use the freed funds to lend unless demand for loans picks up. In June, the RBI had cut SLR by 50 bps to 22.50 percent. Another cut in SLR in August will signal that the RBI is determined to phase out SLR.

Retains CRR

The liquidity in the banking system is at comfortable levels, which reduces the chances of RBI tinkering with the cash reserve ratio (CRR), the portion of deposits banks need to park with central bank upon which they earn no interest, as well. Banks borrowed an average Rs 11,730 crore daily in July through the overnight liquidity window of the RBI as against Rs 16,630 crore since January. Banks borrowing at the marginal standing facility, the emergency borrowing window of banks, too have come down substantially this year.