Monetary Policy Review 2009-10 – Q2 FY10

The RBI in its second quarter monetary policy review has maintained status quo by keeping the key policy rates unchanged – Bank rate at 6%, repo rate at 4.75%, reverse repo at 3.25% and CRR at 5%. While the apex bank has refrained from withdrawal of accommodative monetary policy stance, a large number of policy measures have been undertaken directing towards withdrawal in a phased manner. The central bank has increased the SLR limit by 100bps to 25% of NDTL while keeping the HTM limit unchanged, toned down the money supply (M3) growth target (around 17% yoy from previous 18% yoy), non-food credit growth target (18.0% yoy from earlier 20.0% yoy) and raised inflation outlook (6.5% with upside bias from 5% earlier) by March, 2010. Provisioning norms for lending to commercial real estate have been tightened and further urged banks to increase provision coverage ratio (including specific and floating provision) to 70% by September, 2010. The sluggish credit demand during H1 FY10 has enabled the government to smoothly borrow over 80% of the proposed borrowings. With credit growth likely to revive in second-half of the year, the RBI has insisted banks to step up their efforts towards credit expansion while preserving credit quality. Until the previous policy review where the RBI had placed impetus on managing liquidity, it has now placed emphasis on inflation.

Main policy highlights

• The real GDP growth target for 2009-10 has been kept unchanged at 6% with an upside bias. This is after taking into consideration a modest decline in agricultural production due to drought, albeit supported by faster recovery in industrial production. IIP for the month of August grew 10.4% highest since August 2007. IMF has revised its GDP estimates for the world economy; and now expects it to contract by 1.1% in 2009, from early 1.4%. It expects India GDP to grow by 5.4% for 2009 and 6.4% for 2010, as against 3.1% for the world economy.
• The apex bank has revised the WPI inflation outlook to 6.5% with an upside bias from around 5% in the earlier policy document. After remaining in a negative territory (due to high base effect) for over past three months, the WPI inflation has inched to 1.21%. While the rising WPI inflation could be characterized as being primarily a demand-pull inflation, the recent rise in inflation was largely on account of pricing pressures on food articles and food products. CPI based inflation on the other hand continues to run high. While the RBI has been keeping a constant watch at inflation, the upward revision has put to rest concerns on raising interest rate until Q1 CY10.
• The hefty government borrowings programme had compelled RBI to raise its money supply (M3) growth target to 18.0% from previous 17.0% in the first quarter policy review. With sluggish credit growth during the H1 FY10, the government has borrowed over 80% of its proposed programme. While the money supply growth continues to remain high at 18.9%, the apex bank has now placed impetus on credit to private and commercial sector. It has revised the M3 growth downward to 17.0% from earlier 18.0%.
• RBI has been revised the non-food credit growth target downward to 18.0% from earlier 20.0%. The bank credit growth has fallen to 11.2% yoy as against 29.4% yoy a year ago implying a significant deceleration. On an YTD basis, the system credit is up 4.3% as against 10.5% in the corresponding period of the previous year. While the sharp deceleration in system credit could be attributable to a) slowdown in demand from manufacturing sector b) access to non-bank sources of funds c) lesser demand from OMC d) diversion of funds to mutual funds and 5) un-willingness to lend to real estate, the reserve bank expects the credit growth to revive in H2 FY10 lead by demand from retail. It has urged banks to step up their efforts towards credit expansion while preserving credit quality. The aggregate deposits growth is also revised downwards to 18.0% from earlier 20%. In the recent times, the RBI had placed emphasis on garnering retail deposits.
• While the RBI has refrained from exiting its monetary policy stance, a large number of measures have been taken which direct towards withdrawal in a phased manner. The measures include a) SLR limit hiked by 100bps to 25% of NDTL b) Increase in provisioning norms for lending towards commercial real estate from 0.4% to 1.0% c) Augmenting banks to increase in provision coverage (including specific and floating provision) to 70% by September 2010 d) CBLO to be subject to maintenance of CRR with effect from the fortnight beginning November 21, 2009 e) decrease in limit for export credit refinance facility restored to pre-crisis level of 15%, and withdrawal of special repo facility for banks and to MF’s, NBFC’s, and HFC’s.
• The deteriorating macro-economic conditions during September-October 2008 had forced RBI to reduce the SLR requirement by 100bps to 24% of their NDTL and thereby provide liquidity into the system. However, given the sluggish credit off-take during the H1 FY10, banks have been parking surplus funds under reverse-repo window resulting in SLR investments running high at 27.6% of NDTL. While the RBI has left the HTM limit unchanged at 25%, it has increased the SLR limit by 100bps to 25% of NDTL effective from November 7, 2009. As the system credit growth accelerates, banks shall be under severe pressure in maintaining the requirement.
• The apex bank has reversed its policy stance in relation to credit provided to commercial real estate sector. With concerns on rising non-performing assets largely from real estate, the RBI has strengthened the provisioning norm requiring banks to increase the provisions from current 0.4% levels to 1% levels. In the period of Oct-Nov 2008, RBI had relaxed norms thereby ensuring flow of credit to real estate and also enabling banks to restructure loans under the special dispensation window. This increase in provisioning norms seems un-eventful in the light of the fact that system credit to real estate has grown by mere 3.5% as at March, 2009 from earlier 2.9% as at end March 2008. The increase in provisions is likely to increase the cost-of-funds to real estate companies. Banks like ICICI Bank and SBI with largest exposure to commercial real estate are required to provide for further provisioning. Further, the RBI has advised banks to augment their provisioning coverage (specific provisions and floating provisions) at not less than 70.0% by September 2010.

• Keep a vigil on the trends in inflation and respond swiftly and effectively through policy adjustments.
• To manage liquidity situation actively and ensure that credit demands to productive sectors are met adequately.
• Maintain a monetary and interest rate regime consistent with price stability, financial stability and supportive of the growth process.