Highlights of RBI’s monetary policy of 24 January 2010

The Reserve Bank of India today announced a cut in the cash reserve ratio (CRR) by 50 basis points (0.5 per cent) to 5.5 per cent; but left other key policy rates unchanged in its third quarter (October-December) monetary review today. 

Amandeep Goraya, banking analyst, GEPL Capital, gives a quick overview of the salient points of RBI's third-quarter policy review released today

Policy Action

• RBI cuts CRR by 50 basis points to 5.5 per cent from earlier 6 per cent
  
• CRR cut effective from 28 January
  
• CRR cut will infuse Rs 32,000 Cr liquidity in system
  
• Repo Rate retained at 8.5 per cent
  
• Reverse Repo rate remains unchanged at 7.5 per cent
  
• Marginal Standing Facility stands at 9.5 per cent
  
• Bank Rate retained at 6 per cent
   

Ramifications

• Policy actions to address food, infrastructure supply constraints, important for rate reduction
  
• Fiscal slippages pose significant risk to inflation, policy stability
  
• It is premature to begin reducing policy rates
  
• Reduction in policy rates to be determined by sustained signs of inflation moderation
  
• Risks to growth have increased at this juncture
  
• Crude prices, fiscal slippage, rupee fall continues to pose inflationary risks

Growth Outlook

• Economic (GDP) growth revised downward from 7.6 per cent to 7 per cent
  
• Downside risks have increased since October even as inflation remains elevated
  
• Increased global uncertainty, weak industrial growth, slowdown in investment
  
• Agricultural prospects look buoyant
  
• Slower industrial growth will impact services sector growth
  
• Economy will exhibit modest recovery in 2012-13 

Guidance

• Inflation balance of RBI's monetary policy stance shifted to growth
  
• Cut in CRR to address structural pressures on liquidity
  
• Based on current inflation, premature to begin reducing policy rates
  
• RBI will be constrained in lowering policy rates in absence of fiscal consolidation
  
• Reduction will be conditioned by signs of sustainable moderation in inflation
  
• CRR reduction reinforces guidance that future rate actions will be towards lowering them
  
• Timing and magnitude of future actions contingent on various factors
  
• Policy actions to induce investment & address supply bottlenecks critical
  
• Fiscal slippage poses significant threat to inflation management
  
• Fiscal slippage poses significant threat to macroeconomic stability
  
• Union budget must begin process of fiscal consolidation
  
• Prudent to fully deregulate diesel prices to contain aggregate demand & trade deficit 

Inflation

• Food inflation has moderated more than anticipated
  
• Benefit offset by lower moderation in manufactured goods inflation
  
• Baseline projection for WPI inflation retained at 7 per cent
  
• Rupee depreciation, suppressed inflation in preventing downward revision of inflation
  
• Inflation will remain vulnerable to variety of upside risks

Fiscal Worries

• Gross fiscal deficit for FY12 will overshoot budget estimate substantially
  
• Fiscal deficit could potentially crowd  out credit to the private sector
  
• Fiscal slippages adding to inflationary pressures & continue to pose a risk

Liquidity

• Liquidity conditions have remained beyond comfort zone
  
• Structural deficit in the system has increased significantly
  
• Structural deficit could hurt credit flow to productive sectors
  
• Structural deficit presents a strong case for injecting permanent liquidity

Global Risks

• Sovereign debt concerns in euro zone pose a major downside risk to growth
  
• Uncertainty will adversely affect Indian growth through trade
  
• Slowing capital flows raises concerns about current account deficit

Credit & Deposit Growth

• Credit offtake has been below projected trajectory
  
• Non-food credit growth scaled down to 16 per cent from. 18 per cent
  
• Money supply growth projection for FY12 retained at 15.5 per cent

Impact on banking sector
Liquidity conditions have worsened as repo borrowing has gone up to Rs1,41,770 crore, which is well above the RBI's comfortable zone of plus or minus 1 per cent of NDTL.

 The RBI's CRR cut of 0.5 per cent will infuse liquidity of approximately Rs30,000 crore. We feel this would have a moderate impact on banking stocks, but the market would take it as signal towards RBI's softening stance - thereby impacting markets positively.

The RBI has also cut credit growth estimates to16 per cent from previous estimate of 18 per cent for FY12. We expect to see policy rate cut up to 50bps (0.5 per cent) in RBI's next policy meet on 15 March.