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The Worst Is Over, At Last

Business World Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[In a clear signal that growth is back on its radar, the Reserve Bank of India (RBI) on Tuesday cut the cash reserve ratio (CRR) by 50 basis points to 5.5 per cent. The measure will take effect from the coming Friday (28th January) and release Rs 32,000 crore into a parched banking system. The central bank left the repo rate unchanged at 8.5 per cent. The feeling is that it will done either at the next mid-quarter review for 2011-12 on March 15; or when the Monetary Policy for 2012-13 is announced on April 17. By then, the results of the five state elections in Uttar Pradesh, Punjab, Uttarkhand, Manipur and Goa would have come in. If the political gains from the state elections are to be loaded in favour of the Congress-led UPA government, it may announce a raft of reforms in the Union Budget (slotted for the second week of March at the latest) and do a one-two with rate cuts from Mint Road. The RBI also gave a hint to the government on what it should do in the Union Budget: in the absence of credible fiscal consolidation, the RBI will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending. "The forthcoming Union Budget must exploit the opportunity to begin this process in a credible and sustainable way", it said. On Monday, it gave two suggestions in its Macroeconomics and Monetary Developments Third Quarter Review 2011-12'. The attainment of the Union Budgets 2010-11's rolling target of gross tax revenue-GDP ratio of 10.8 per cent for 2012-13 critically depends on timely implementation of DTC (Direct Tax Code). It is expected that DTC system would improve compliance levels as rates of corporation tax and surcharge are reduced and tax base is widened. "While greater uncertainty surrounds the introduction of GST, a consensus needs to be built for the successful rollout of GST in order to further improve compliance and enable overall tax buoyancy to return to pre-crisis levels. In the short-run, reliance on temporary measures such as disinvestment cannot be avoided. However, plans in this regard would need to be calibrated to market conditions, so that revenue proceeds can be well spaced", the Review noted. CRR Cut, But Repo Rate Unchanged The central bank pointed to the tight liquidity conditions beyond its comfort zone. It used open market operations (OMO) -- wherein it buys government securities from banks for cash -- to inject Rs 70,000 crore from November to mid-January 2011. But the structural deficit in the system increased significantly, which could hurt the credit flow to productive sectors of the economy. RBI said "it presents a strong case for injecting permanent primary liquidity into the system". It is a reference to inter-bank liquidity. It remained tight for most of fiscal 2011-12, but turned for the worse in the second half of November. This was largely due to the central bank's dollar sales to support the rupee which fell below the 50 to dollar to hit a life low of 54.23 on December 15, 2011. Dollar sales sucks out an equal rupee amount from the system; and this also coincided with advance tax outflows of nearly Rs 50,000 crore. As a result, average borrowings by banks from the RBI window increased to Rs 92,000 crore during November and further to Rs 1,20,000 crore by in January (up to January 20th). It had hovered at Rs 48,000 crore in April-September 2011. The liquidity deficit had been consistently above Rs 1,50,000 crore during the past week. The RBI has gone on record that the desired liquidity deficit should be around 1 per cent of net and demand time liabilities (NDTL. This includes saving, fixed deposits and call borrowings) of banks for effective transmission of monetary signals, while keeping adequate liquidity to fuel the growth engine. And 1 per cent of NDTL presently works out to about Rs 64,000 crore.  With a CRR cut of 50 bps, the liquidity deficit would reduce to a shade less than Rs 1, 20,000 crore, much higher than the desired level. Going Ahead "The system therefore can expect another cut before this fiscal end, provided inflation numbers are closer to projection. This one step alone takes care of the structural liquidity deficit issue, as CRR is the most effective tool for permanent liquidity infusion. The initial response of the market has been quite positive and the Sensex shot up by about 300 points, breaching the 17,000 mark while the rupee gained to less than Rs 50 per suggesting increased foreign institutional interest in Indian Equities", says Shyam Srinivasan, MD & CEO of Federal Bank. Today's move is the final step of RBI reversal of its crisis-driven expansionary policy in October 2009. Between January 2010 and October 2011, it cumulatively raised the CRR by 100 basis points and the the repo rate 13 times by 375 basis points. This monetary policy response was calibrated on the basis of India specific growth-inflation dynamics. However, in view of slowdown in growth, especially investment activity and expected moderation in infl ation beginning December, it was decided to pause on repo rate hikes from the review in December 2011. The repo rate has been untouched at as the central bank felt it was premature to cut it now. "The reduction in the policy rate will be conditioned by signs of sustainable moderation in inflation". Headline wholesale price index (WPI) inflation, which averaged 9.7 per cent year on year (YoY) during April-October 2011, moderated to 9.1 per cent in November and further to 7.5 per cent in December. But though headline WPI inflation is moderating, it largely reflects a sharp deceleration in prices of seasonal food items. "Inflation in respect of other key components, particularly protein-based food items and non-food manufactured products remains high. Moreover, upside risks to inflation arise from global crude oil prices, the lingering impact of rupee depreciation and slippage in the fiscal deficit", RBI said. The RBI has maintained that the inflation target of 7 per cent by end-March 2012 would be attainable despite the slow improvement in core sector inflation and uncertainties in the global economies. This target appears to be reasonable. More importantly, core inflation should move down for any RBI action on this front. "Speculation that CRR cut is guidance for interest reduction in the future, it is more likely that the RBI would be more cautious before reducing interest rates as it would be premature to begin reducing policy rates before a substantial and sustainable dip in overall inflation. We do not expect this before early 2012-13", says Madan Sabnavis, chief economist at Care Ratings. But there is a catch. The bulk of the liquidity available went into government securities, not credit as few companies were big borrowers at the prevailing interest rates; few had huge capital expenditure plans lined up. "The CRR released funds could flow mainly into government paper and support borrowing programme of government as commercial credit growth is sluggish due to demand and interest rate conditions", adds Sabnavis. Adds Rohini Malkani, economist-Citi (India): "The RBI has lowered its 2011-12 GDP estimate to 7 per cent from 7.6 per cent. It has said that the deceleration is primarily due to a slowdown in investments, where revival is contingent on domestic policy measures. If this does not pick up, growth could trend lower; further aggravating inflationary pressures". The RBI's move today may well be step in the right direction, but much more needs to be done to get the economy going.