RBI, govt appear in sync on liquidity, credit

After the Reserve Bank of India (RBI) made it clear in the October monetary policy that it was moving away from a ‘neutral’ stance to ‘calibrated tightening’, not many had hopes of a rate cut this time around. But the market and the government were surely looking forward to more measures on liquidity to small businesses gasping for breath. Top finance ministry officials sent enough signals that they wanted credit and liquidity eased.

On Wednesday, in its fifth bi-monthly monetary policy, Governor Urjit Patel did exactly that. He did not touch the conventional repo rates nor did he lower the cash reserve ratio (CRR) for more money to flow into the system. But, he chose to open multiple other unconventional taps which could ensure system-wide cash flow on a gradual basis to take care of a credit crunch.

Of course, the central bank did not open a direct window for liquidity to non-banking finance companies (NBFCs) but gave enough assurance that it will stand like a rock behind them so that they do not feel the credit crunch.

Most of the NBFCs and housing finance companies (HFCs) have to do a lot of balance sheet adjustments. Some of them do have good assets on their books but some are struggling and their plight has come into open after the IL&FS defaults. RBI would not have done any good to them, in the long run, if it had made loan flow easier.

Easing SLR norms

Coming to the availability of cash flow to other sectors, the promise by the central banks to relax the statutory liquidity ratio (SLR) norms would ensure the gradual release of a lot of money from commercial banks remaining blocked due to statutory reasons. They would get channelised into investment, thus taking care of credit crunch.

Under the strict SLR norms, banks are required to maintain a large amount in the form of cash, gold reserves, and government-approved securities before providing credit to the customers. At present, the SLR requirement stands at 19.5%. The central bank wants to bring it down to 18% in about six quarters from January. The decision will not only free up more cash for productive usage but also ensure lower yields on government securities. The result has started showing. The yields on 10-year government bonds have begun softening.

The SLR cut becomes more pronounced when linked with the sharp cut in inflation forecast that the RBI did this time around. The RBI had cut the October-March (2018-19) inflation forecast to 2.7%-3.2% from a high of 3.9%-4.5% earlier. The two reductions together are expected to cut costs for borrowers in a significant way. According to Kotak Mahindra Bank, the move would increase high-quality liquid assets into the system.

The biggest surprise from the RBI policy, however, came from RBI Deputy Governor Viral Acharya who said that the increased pace of the central bank’s open market purchases since October were likely to remain in place for the rest of the year. Around Rs 1.36 lakh crore of bond buys and a promise to do Rs 40,000 crore more in December and keep the tap open essentially implies that a major chunk of the government’s net borrowing will be taken care of by RBI this year. The government is scheduled to borrow Rs 3.82 lakh crore on a net basis from the market this year.

New benchmarks

Additionally, the linking of interest rates on home and auto loans to a new benchmark is also expected to spring a positive surprise on borrowers as it will ensure that when RBI reduces key interest rates, the outstanding bank loans get automatically cheaper without the borrowers having to ask for that. The transmission can be tracked better in the new benchmarking and the consumer has the option to go and check what is happening to his home or auto loan rates. A repo rate cut would have done that but would not have ensured a smooth transmission in today’s environment.

In order to enable banks to forecast their liquidity requirements with a greater degree of precision, RBI to provide information on the daily CRR balance of the banking system to market participants on the very next day. Accordingly, the daily money market operations statement will also contain the CRR figure for the previous day, with effect from December 6.

The CRR balance of banks at the end of the day was until now being disclosed with a lag of two to three days while the details of the currency in circulation are being released with a lag of one week.

While giving all the needed relaxation for improved lending to micro, small and medium enterprises, the central bank decided to set up an expert committee to identify causes and propose long-term solutions for the economic and financial sustainability of the MSME sector.

This was precisely the kind of rescue operation the government wanted from the RBI for a sector which contributes significantly to employment, entrepreneurship, and growth in the economy. The sector, however, remains, by their predominantly informal nature, vulnerable to structural and cyclical shocks, at times with persistent effects.

On a net basis, the RBI has tried to help growth engines fire on all cylinders and cannot be accused of following a pro-cyclical policy. The fact that the finance ministry chose to be silent after the policy announcement indicates they are in sync, at least on the
liquidity front with the latter waiting patiently for lifting credit restrictions on some PSU banks.

The Economic Affairs secretary, Subhash Chandra Garg gave a mild reaction on SLR move as it will have some implications for the government securities. However, he said the momentum created by the reduction in oil prices and reversal of foreign flows had resulted in further moderation of yields post policy announcement. There was no other comment from the government.

After doing all that, the RBI also hinted a softening of stance in the future monetary policy if the macroeconomic data it tracks are robust going forward and, the financial market volatility is under control. A lot of things will now depend on how the trade war scenario pans out between the US and China and what impact it has on the world trade because the external sector remains volatile.

The OPEC decision to cut crude oil production will also have an impact on its price, which if moves upwards, will be bad for India again.

Be that as it may, the RBI appears to have bought peace with the government for now. At least till December 14 when the next Board meeting of the Central bank is held.

DH News Service