Subbarao pleases all, including RBI

The higher than expected 50 basis points rate cut has pleased all concerned including the RBI. The government is happy as it believes a rate cut will help push up growth, markets are happy as the rate cut was higher than expected and the RBI is happy as it does not have to act in haste in the next few policy reviews.

The 50bps rate cut has also shifted the focus away from the RBI, as both the government and the markets can no longer look towards the RBI for help when things go wrong. RBI can go about its job of assessing the growth and inflation situation without any pressure from external forces.

What is RBI’s assessment of the economy? The projections of the RBI for fiscal 2012-12 are a GDP growth of 7.3 percent, broad money supply (M3) growth of 15 percent, deposit growth of 16 percent and credit growth of 17 percent. Inflation is expected to end the current fiscal at levels of 6.5 percent. The economy is closing fiscal 2011-12 at a GDP growth rate of 6.9 percent with monetary aggregates growth at 13.1 percent for M3, 13.8 percent for deposits and 16.3% for credit (end February numbers as March numbers do not reflect the full year trend due to banks year end shoring up of growth numbers).

The projections of the RBI are in line with a 50bps rate cut. Going forward any deviations from the projections given in the policy will prompt the RBI to act and any action on policy rates will be downwards and not upwards.

RBI is a bit more pessimistic on inflation staying sticky at levels of 6.5 percent to 7 percentas its own analysis of domestic demand and global economy is not highly positive. RBI expects modest growth in global economy while it has highlighted the fall in corporate investment intentions (projects sanctioned for loans have shown a dip of over 60 percent from 2010-11 over 2011-12). RBI believes that suppressed inflation in administers prices of food, fuel, power and fertilizers are leading to inflation remaining sticky at higher levels. The fact that a modest global economic growth and a weak corporate investment demand is inflation dampening has not figured in RBI’s calculations.

RBI is hedging its bets by stating that further rate cuts are not given as threats to inflation exists in the form of high fiscal deficit, rising current account deficit and inadequate pass through of prices into the economy. These issues cannot be addressed by the central bank and has to be addressed by the government. However the RBI has to act on inflationary pressures and growth trajectory and if both are showing signs of aiding policy cuts, the central bank will have to react with more rate cuts.

The liquidity issue has been addressed adequately by the RBI by allowing banks to access the MSF (Marginal Standing Facility) for up to to 2 percent below their SLR (Statutory Liquidity ratio). The rate cut has brought down the MSF rate from 9.5 percent to 9 percent and if banks are in desperate need of liquidity, funds are available at 9 percent. However banks are running SLR of around 29 percent of NDTL (Net Demand and Time Liabilities) and they have room to borrow around Rs 300,000 crore at repo rates of 8 percent. The access to liquidity at lower rates will bring down pressure on banks to hike deposit rates and will also bring down banks borrowing costs by 100bps in the CD (Certificate of Deposit) market. Liquidity in the system has eased by Rs 100,000 crores since end March on the back of government spending and releasing of hoarded liquidity by banks. Liquidity is comfortable, negating the need for a cut in CRR (Cash Reserve Ratio).

The bottom line is RBI will cut rates down the line but at its own pace and will.