First hint of end to tight money policy

Subbarao: Different stance

Mumbai, Sept. 6: Reserve Bank of India governor Duvvuri Subbarao appeared to abandon his hawkish monetary stance just 10 days before a crucial monetary policy review when he said both the statutory liquidity ratio (SLR) and the cash reserve ratio (CRR) needed to be lowered but in a calibrated manner.

Taken together, the CRR and the SLR stand at 30 per cent, which is “quite high and they need to come down. But that has to happen gradually”, Subbarao said today at a symposium organised by the Indian Institute of Foreign Trade.

The CRR, which currently stands at 6 per cent, is that portion of bank deposits that lenders must maintain with the apex bank. The SLR, at 24 per cent, is the proportion of deposits that banks must invest in government bonds and other approved securities.

The RBI uses the two ratios to control the level of liquidity within the financial system.

Subbarao has raised the policy rate — the repo — 11 times in the past 18 months, making him one of the most hawkish central bankers in the world. The repo has risen 325 basis points to 8 per cent.

The repo is the rate at which the RBI provides funds to banks.

Only Brazil has raised its policy rate more aggressively by 375 basis points since August 2009. However, Subbarao’s rate hike spree has been more frenetic since it only started in March last year as the RBI tried to tamp down on inflation, which is currently running at 9.22 per cent.

The RBI had stunned the Street by raising the repo by 50 points at the July 25 meeting of policymakers. A statement put out by the RBI later showed that there were several people at the meeting who wanted the RBI to refrain from raising the policy rate but Subbarao chose to ignore their advice.

Bankers have been anticipating another rate increase of 25 basis points in the repo on September 16 —and that is why Subbarao’s uncharacteristically dovish statement has grabbed attention.

In the past, the RBI governor has said that he was prepared to sacrifice a little bit of economic growth in his fight to bring prices under control.

The RBI last reduced the SLR by 1 per cent to 24 per cent in December last year to help the banking system which was facing a liquidity deficit. It raised the CRR in April last year.

The RBI governor said the two ratios at one time stood at 65 per cent. The central bank intended to bring it down from the current level of 30 per cent in a calibrated manner.

“We should bring it (SLR) down so that credit is available and the private sector is not crowded out,” he added.

The RBI governor, however, added that the two ratios could not be scrapped. “It is SLR which has protected us (Indian banks) from the global financial crisis,’’ he said, adding that the Basel II guidelines contained other provisioning requirements that were similar to SLR.

Subbarao’s comments pushed up government bond yields on concerns that any move to lower SLR and CRR could prompt banks to offload some of their bond holdings. Banks’ SLR holding is estimated around 29 per cent of their deposits.

The governor also said that the RBI was looking to reintroduce inflation-indexed bonds. These are bonds where the principal is indexed or adjusted to the rate of inflation and the interest is paid on this inflation-adjusted principal.

An inflation-indexed bond was first introduced in December 1997 but it didn’t evoke enthusiastic response.