RBI waits for the Budget

Central bank stays its hand on interest rates

As it turned out, the Reserve Bank of India (RBI) did not do what some people expected; it held the repo rate at 7.75 per cent. Its decision to reduce the rate by 25 basis points on January 15 was, in effect, simply an advancement of the action that it would have otherwise taken on Tuesday. Its decision not to follow up with another cut was based on the fact that there was no new information of direct relevance to monetary policy available between January 15 and February 3. While that may be true, a judgement must also be made on what the appropriate level for the repo rate is in the current macroeconomic situation and how quickly to get there. From this perspective, given the relatively benign inflationary situation, including, significantly, the drop in household inflationary expectations, it could be argued that steady and consistent movement towards that rate is the best course of action. Be that as it may, clearly, the next trigger for a possible rate action is now the Union Budget. If the fiscal numbers provide adequate assurance on consolidation, going by the logic of the January 15 action, there will be little reason to wait till the next policy review, the first of 2015-16, on April 7.

Having chosen to stay his hand on the repo rate, Governor Raghuram Rajan did take his foot off the brake a little by reducing the statutory liquidity ratio (SLR) by 50 basis points to 21.5 per cent of net demand and time liabilities. There are two dimensions to this. In the short term, this counts as monetary easing, as it infuses a significant amount of liquidity into the banking system. Theoretically, the system's capacity to lend commercially has increased, which is consistent with the signs of recovery that the economy is showing. But in practical terms, it is another matter if banks will be willing to lend. However, the long-term implications of a reduction in the SLR are also significant. The RBI has been steadily reducing this requirement, consistent with Governor Rajan's position on reducing "pre-emptions" by the government from the banking system. The less the government can depend on banks to buy its securities, the more active the market becomes, a basic requirement for the development of a robust bond market. However, the current pace of the correction is perhaps too slow to have much of an impact for a long while.

This announcement also addressed regulatory and development issues. A significant move was the raising of the limit on residents' access to foreign exchange. This had been brought down sharply during the currency problems of 2013 and then partially reversed. It has now been raised to $250,000, higher than the earlier cap of $200,000, but now subsuming other flexibilities that individuals had on current account transactions. This reflects the RBI's assessment that foreign exchange inflows are going to be large and potentially disruptive, so all channels to create demand for forex need to be activated. On the banking side, two external advisory committees to scrutinise applications for small finance banks and payments banks have been set up. Both categories appear to have attracted the attention of some very large corporate players. It remains to be seen whether the RBI sheds its apprehensions about licences to corporate groups in the name of financial inclusion.