RBI 2nd June 2015 policy review comes in the backdrop of the central bank purchasing USD 56.8 billion in fiscal 2014-15, adding Rs 3.4 trillion of liquidity into the system. Over and above spot USD purchases, RBI has net bought USD 40 billion in forwards taking total outstanding forward contracts to USD 8 billion as of March 2015 against an outstanding net forward sale of USD 32 billion as of April 2014. Expiry of forward USD purchases adds liquidity into the system.
The effect of RBI fx operation dwarfs the repo rate cut of 25bps effected in January and March 2015, taking total cut in 2015 to 50bps. Apart from lowering money market rates, rate cuts have had no effects on government bond yields that have actually moved higher since January 2015. Chart 1.
Bank credit growth is hovering around 10.16% levels on a year on year basis as of May 2015 from growth levels of 10.7% seen in January 2015. Banks are reeling under NPA’s and restructured assets that are at 10.9% of gross advances as of March 2015.
The question RBI is asking itself is whether Repo Rate cut is required as of now. Liquidity is easy in the system on the back of RBI infusion of liquidity through USD purchases, credit spreads are low with benchmark AAA credit spreads at levels of 40bps to 60bps over government bond levels. Chart 2.
System liquidity as measured by bids for repo, term repo and MSF in RBI liquidity adjustment facility auctions are at levels of Rs 930 billion largely due to the government running a surplus of over Rs 750 billion that is parked with the RBI. RBI will be buying USD this fiscal to shore up fx reserves in order for the country to withstand potential volatility when the Fed starts to hike interest rates this year.
Global liquidity is highly positive with ECB and Bank of Japan together adding USD 125 billion a month of liquidity through asset purchases. India’s CAD is down to levels of 1.3% of GDP and if oil prices stay at levels of around USD 60/bbl to USD 70/bbl, CAD is unlikely to rise much in this fiscal year. India’s Balance of Payment position is expected to be highly positive in this fiscal year and RBI could well end up buying around USD 40 billion to USD 50 billion adding more liquidity into the system.
RBI adding liquidity through fx intervention has issues of inflation if this liquidity goes towards speculative assets. Hence RBI will be looking to sterilize part of the liquidity through issue of MSS (Market Stabilization Scheme) bonds and through OMO bond sale auctions. RBI may not want to make liquidity cheaper by lowering the Repo Rate especially in the face of an impending below normal monsoons for India.
A cut in CRR is not required at all given that RBI is adding liquidity through fx intervention. SLR has already been cut 150bps last fiscal to levels of 21.5% of NDTL and given that banks are running around 29% SLR in their books, a SLR cut will have no impact on liquidity position of banks.