Many banks hold government and SLR securities more than the statutory threshold. RBI has reduced the liquidity provided under the export credit refinance (ECR) facility from 50% to 32% of eligible export credit outstanding. It has simultaneously introduced a special term repo facility of 0.25% of NDTL of the banking system, which will fully compensate the ECR reduction. It will also continue to provide liquidity under the seven-day and 14-day term repos of up to 0.75% of NDTL.
If you read between the lines, there are several positive indicators in this policy statement. The policy commentary on inflation is far more optimistic than what it sounded in the previous policy statement in April. It takes a distinctly dovish stance "if economy stays on course, further policy tightening will not be warranted and... (there may be) headroom for an easing of the policy stance."
Monetary easing will aid the government's effort to accelerate economy's growth engine as quickly as possible. The SLR reduction is in line with RBI's medium-term strategy as it improves the efficiency of money and bond markets. It also indicates that the government intends to borrow less this year, given that fiscal deficit has reduced significantly and the strong mandate improves visibility on further fiscal consolidation.
Over the longer term, SLR reduction (we may expect more in future) will not only provide commercial banks some room for lending but also improve their margin. Overall, RBI remains committed towards maintaining adequate liquidity in the banking system. It has, therefore, fully compensated the Rs. 20,000 crore liquidity squeeze from export refinance by liquidity infusion through special term repo. The central bank is trying to promote use of term repo, again, in line, with its strategy for tiered money market.
RBI is also optimistic that government actions will now be positive for the economy. It feels increased risk to food inflation from a weaker monsoon and risk of higher commodity prices due to geopolitical tensions are offset by expectations of stronger action on food supply, fiscal consolidation and recent rupee appreciation.
While a further repo hike is a rare possibility, a rate reduction in the near term also may not happen, given some uncertainties on monsoon.
RBI would want the disinflationary effects of rate increases undertaken during September 2013-January 2014 to continue. We may expect of 50-75bps rate easing in H2 FY15. One should closely watch how the host of factors like monsoon, global liquidity which affect inflation play out in the next three months.
Liquidity conditions improved in April and May. With the banking system deposits growing faster than advances, continued decline in short-term rates and the expected gradual moderation in core inflation, we expect commercial banks to cut deposit rates soon. We can expect actual lending rates for projects to come down, with easy liquidity, notwithstanding unchanged repo rates. This, coupled with positive macro environment, will provide the much-needed impetus to private sector investment. The same, in turn, will help accelerate economic growth and employment generation. To sum up, Indian business can look forward to better days ahead.
Follow our Chairman Mr Nirmal Jain on Twitter @JainNirmal for his real-time updates and views on policy, economy, markets and more.
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