RBI will cut CRR (Cash Reserve Ratio) by 50bps in its March 2012 policy review, but the CRR cut will not help bring down cost of funds for banks. The reason RBI will cut CRR is that system liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI has become extremely tight. Bids for repo touched Rs 180,000 crores on the 28th of February 2012, an all time high. System liquidity has tightened by around Rs 40,000 crores since the end of January 2012 and will get tighter going into March. Advance tax outflows around the 15th of March and fiscal year end pressure for money will take up bids for repo to well over Rs 200,000 crores.
The RBI will cut CRR to improve system liquidity but it will not really help in easing liquidity by much. A 50bps CRR cut can add around Rs 32,000 crores into the system, which will not help by much when liquidity is deficit by over Rs 200,000 crores. One year CD (Certificate of Deposit) rates have gone up by 40bps to 10.2% over the last one month and the rates will not come off by much on a CRR cut.
Excess SLR as a liquidity tool is gaining more value in present conditions
Banks holding of government bonds is around 29% of NDTL (Net Demand and Time Liabilities). The statutory limit (SLR or Statutory Liquidity Ratio) for banks to hold government bonds is 24% of NDTL. Banks effectively have 5% of excess government bonds that they can use to borrow funds from the RBI. 5% of excess SLR amounts to around Rs 290,000 crores (on a deposit base of around Rs 58 lakh crores). Banks are using this excess holding of government bonds to access funds from the RBI.
The excess SLR is helping RBI overcome the high liquidity deficit in the system. It is also keeping overnight rates steady at around repo rates of 8.5%. Hence only a cut in the repo rate can bring down the cost of funds for banks.
Liquidity has tightened despite positive factors
Liquidity has tightened despite release of Rs 32,000 crores into the system through a CRR cut of 50bps in the RBI January 2012 policy review. RBI has also purchased bonds worth Rs 30,000 crores in the month of February through OMO (Open Market Operations) bond purchase auctions. Taking the CRR cut and RBI bond purchase into account, liquidity has tightened by Rs 100,000 crores in February 2012.
The other sources of liquidity tightness such as USD sales by the RBI, government surplus and currency in circulation have not acted up to cause this liquidity tightness. The INR has been on an uptrend in February, gaining close to 1% over the month on the back of FII portfolio flows that have crossed USD 4.5 billion calendar year to date and RBI intervention has not been noticed. RBI had sold USD heavily in December 2011 to stem an INR fall. RBI had sold USD 7.8 billion in December 2011 to protect the INR that had lost close to 15% against the USD in the second half of calendar 2011. RBI USD sales did impact liquidity but it was factored in the liquidity figures in January.
The government has not been running a surplus balance with the RBI while the currency in circulation has gone by Rs 20,000 crores over the month of February. Rise in currency in circulation impacts system liquidity adversely as it is a leakage of money out of the system.
One factor affecting liquidity could be higher oil imports leading to higher demand for USD by oil importers. Oil prices have gone up by over 13% calendar year to date and the higher value of imports lead to increased demand for USD to pay for the imports. However part of excess demand for USD for oil imports should have been compensated by the portfolio flows of over USD 6 billion. Higher oil imports can only partly explain the liquidity tightness. There are still many grey areas on the liquidity front that are yet to be explained.
RBI has stated that the CRR cut is an indication of the change in its policy stance from tightening policy to easing policy rates. The timing of rate cuts is not given by the central bank but the trajectory of inflation will be clearer in March and is more likely to be below RBI’s forecast of 7%. The government will be presenting its budget for 2012-13 on the 16th of March and will sound out that it is addressing its fiscal issues in the budget. RBI cited government’s spending on subsidies as a factor for not reducing repo rates, and if government can show better fiscal management in its next year’s budget, RBI will cut repo rates confidently.
Revision of GDP growth for 2011-12 from 7.6% to 7% is an indication of private demand coming off in the economy. The fall in credit growth to below 16% levels from around 22% levels in the beginning of fiscal 2011-12 signifies lack of risk appetite by lenders in an uncertain economic environment. The fall in corporate investment intentions by 77% in the second quarter of 2011-12 on a year on year basis signifies the lack of investment demand in the country. Tight liquidity condition coupled with interest rates staying high in the system will lead to a slow fourth quarter GDP growth. RBI will have more reasons to cut repo rates in March given growth slowdown.
The markets have been bullish going into the policy with equities rallying by over 8% month to date and the Rupee appreciating by over 5%. Bond yields have come off by 20bps since the beginning of January 2012. The markets will continue on its broad uptrend on expectations of more rate cuts in March, but given the sharp rally this month volatility will increase.