balancing impression and expectation...RBI did its best!

Balancing act of RBI.....win-win proposition

The expectation into December mid quarter review of monetary policy was mixed. While most expected 25 bps cut in CRR, the need was felt that RBI kick-start the rate reversal cycle with baby-step approach of 25 bps cut in Repo rate, if not in Reverse Repo rate. The expectation of CRR cut was based on RBI’s previous stance of easing CRR to cover lumpy advance tax outflows, and not as monetary guidance. A no-change stance was seen as extreme step of caution and lack of optimism (and confidence) to bite the bullet. On the other hand, “big daddy” of the market, SBI expected an aggressive 50 bps cut both in CRR and policy rates. It is obvious that all market participants look up to SBI and keep close watch on their views and actions. It sends mixed (and discomforting) signals to market stake holders when the decision of the RBI is on the “other extreme” to that of expectations from SBI, the “market-maker” and “lender-of-the last resort” to the borrowing community.

There would have been twin benefits to commercial banks from SBI’s expectations. The banking system needs ramp-up in revenues to cover higher NPA provisions before end of FY13. The ramp-up (in revenues) can happen through sharp increase in Net Interest Income driven by significant fall in the shorter end of the deposit rate curve and huge mark-to-market gains in the SLR (and excess SLR) portfolio; combination of higher NII and profit on sale of investments (other income) will adequately meet higher NPA provision coverage without impact on the profitability of commercial banks. Most PSU Banks will like this scenario. There is also need to build the loan book. The excess SLR held by PSU Banks are funded out of their deposits; being provider of liquidity in call/over-night market, the need to refinance excess SLR from Repo counter is limited. A sharp fall in lending rates (driven by cut in policy rates) will enable PSU Banks for better deployment of funds at higher yield. This is seen as valid (and logical) expectation of PSU Banks (from RBI) as they are seen to be on-tap to the rescue of the Government (and RBI) when in need.

RBI’s position is also not an enviable one having to fight against all odds. It will be difficult to explain rate cut action after setting the benchmarks linked to elevated headline (wholesale and retail) inflation and low real interest rates. The off-shore investors would have read “rate cut” action as “pressure” from “the above” and the autonomy (and independence) of RBI would have come to doubt. RBI had to balance between impression of off-shore investors and expectation of SBI/PSU Banks. While delivering to off-shore investors, RBI has pleased SBI through strong guidance statement – “In view of inflation pressures ebbing, monetary policy has to increasingly shift focus and respond to the threats to growth from this point onwards. Liquidity conditions will be managed with a view to supporting growth, thereby preparing the ground for further shifting the policy stance to support growth”. This strong statement should provide comfort to SBI that their expectation of 50 bps rate cut is not far behind. Till then, their excess SLR investment book will be protected through OMO bond purchases. The impact from OMOs will be of beneficial to the investment book while CRR cut may hurt bond yields, thereby cutting the market-to-market gains.

So, it is a win-win stance of RBI to protect the interests of two large stake holders, off-shore investors and the SBI. The Government (and the borrowing community) can afford to take this disappointment when there is optimism little ahead.

Moses Harding