Reserve Bank of India’s (RBI) move to deliver a strong dose of additional liquidity to an economy which is straining for cash and showing signs of slackening in tempo, is welcome. So is the decision to signal a further drop in interest rates at a time when the price indications are that inflation should cease to be the policymaker’s primary concern. The multiple measures announced on Saturday — a 50 basis point cut in the repo rate to 7.5 per cent, a 100 basis point cut in the cash reserve ratio (CRR) to 5.5 per cent, and making permanent the reduction in the statutory liquidity ratio (SLR) to 24 per cent — show that RBI is drawing upon its whole arsenal of measures to ensure that the economy's growth momentum does not slacken any more than is unavoidable. The central bank has also addressed the needs of a troubled sector; opening a refinance window for loans to non-banking financial companies is a welcome piece of targeting at a time when the primary sources of NBFC finance (mutual funds) are themselves facing the pressure of premature redemptions. Equally sensible is the decision to start unwinding the market stabilization bonds—if there is any truth to the charge that banks have a cushion in their SLR holdings, RBI buying back these bonds will replace interest-bearing securities that the banks hold, with plain cash—and that will give banks additional incentive to lend to customers.
What is odd about Saturday’s announcements is that they come barely a week after RBI did virtually nothing in its scheduled quarterly review of monetary policy, disappointing most observers. And four days before that, RBI had surprised most people with a 100 basis point reduction in the repo rate. This go-stop-go approach raises questions about whether RBI has a clear view of the problems faced by the financial and real sectors of the economy, and what it needs to do—as also when it needs to do it. Still, belated correctives are better than none at all.
Saturday’s decisions have of course been made easier by the continued decline in inflation as measured by the wholesale price index, which is on course to slip back into single digits in the near future, and can be expected to continue to drop because the global economic slowdown acts as a strong deflationary force for everything from metals to chemicals, and from agricultural products to petroleum. Against that backdrop, it is quite clear that interest rates are now too high for most players, quite apart from which RBI would also have noted that central banks everywhere have been slashing interest rates in a bid to counter-act demand contraction. Rate cuts have been announced by the US, China and Japan as well as smaller economies like South Korea and Taiwan. The European Central Bank is also mulling a rate cut. So the worries on interest rate differentials have eased. If enough liquidity has been pumped into the system, then banks will be able to respond by dropping their lending rates, and the initial signs from the latest rate cut are more promising than was the case two weeks ago.
There remains the possibility that even these steps may not be enough, and that more is required (for which RBI has enough leeway, since the CRR can be dropped by another 250 basis points). Certainly, there is the risk that the latest steps do not do enough to counter-act the sucking out of liquidity that is the result of RBI trying to shore up the rupee’s external value. Having spent about 12 per cent of its foreign exchange reserves in this effort during the past month alone, RBI must also be asking itself whether it is a good idea to stick to its current course, or to allow the rupee to slip a little further in an orderly fashion. That could have some inflationary consequences, through higher costs of imports, but is a small risk in the over-all context. The benefit will be an easing of the domestic liquidity situation.
