Third Quarter Review of Monetary Policy 2011-12

(Announced on 24/01/2012)

by

Rajesh Goyal, Executive Consultant

Third Quarter Review of Monetary Policy 2011-12

RBI Governor, Dr D Subharao announced that based on the assessment of the current macroeconomic situation, the following changes have been made in the monetary policy :-

• Cash Reserve Ratio (CRR) of scheduled banks has been cut by 50 bps (basis points) i.e. CRR has been reduced from 6.00% to 5.50% of the Net Demand and Time Liabilities (NDTL).  The new CRR will be effective from the fortnight beginning from 28th January, 2012

However, all other policy rates, viz, Repo Rate, Reverse Repo Rate, Marginal Standing Facility Rate, Bank Rate, SLR have remained unchanged. (The Repo rate will continue to remain at 8.50%.  The reverse repo rate under the LAF, determined with a spread of 100 basis point below the repo rate, will continue at 7.5 per cent, and the marginal standing facility (MSF) rate, determined with a spread of 100 bps above the repo rate, at 9.5 per cent)

The step taken by RBI Governor in the present scenario deserves to be applauded.  Tge market was slightly jittery and was not sure whether Dr Subbarao will be generous enough to relax the CRR as recent developments have shown him as a tough man as far as policy rates are concerned.

This single step will inject about Rs.320 billion in the system.   The major considerations behind this move have been :-

(a) Growth of the Indian economy is decelerating and risk to growth has further increased due to various national and international issues;

(b) Liquidity conditions have remained tight beyond the comfort zone of the Reserve Bank.  Although the RBI has conducted open market operations, and injected liquidity of over ` 700 billion, yet the structural deficit in the system has increased significantly. All this could hurt credit flow to productive sectors of the economy. The large structural deficit in the system presented a strong case for injecting permanent primary liquidity into the system

(c) Although WPI inflation has recently moderated yet it is not broad based and is mainly owing to sharp deceleration in prices of seasonal food items.  Reduction in repo rates at this stage was not appropriate as upside risks to inflation from global crude oil prices, the lingering impact of rupee depreciation, and slippage in the fiscal deficit is still looming large.

We at AllBankingSolutions.com view this cut in CRR as a positive sign from RBI which will certainly change the market mood (equity as well as debt market) which was certainly needed to give a flip to Indian economy.   However, we have to be cautious and RBI needs to closely watch various parameters and fundamentals of the economy, both at domestic and international level.  We are not out of the woods and any slippage even on one front can hurt the Indian growth story, and new optimistic trend may not turn to be a bubble.  The policy clearly indicates that the major areas of concern are :-

    1. Euro crisis is still far from over and sovereign debt concerns in the coming months  from the European countries can pose a major risk;

    2. The slippage in the fiscal deficit, owing to various reasons, can add to inflationary pressure and may also squeeze the credit to private sector.  The government has to take certain firm steps to curb the habit of over spending.

    3. The ever increasing NPA in banking sector (problems in sectors like aviation, power have been in news recently) can dampen the sentiments and bankers may show aversions in lending to sectors facing troubles at present.

    4. Risk to food inflation continues to be high as n the absence of appropriate supply responses, the food inflation can show upward trends any time

    5. The global energy prices continue to pose a risk to growth and inflation

    6. Revision in domestic administered prices can also put pressure on the inflation

Let us hope that coming months will bring cheers to our economy.