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Key Measures
Repo rate hiked by 25bp to 6.25%
Reverse repo rate hiked by 25bp to 5.25%
CRR left unchanged at 6.0%
Key Takeaways
Inflation RBI's priority in FY2011
The RBI in its 2QFY2011 monetary policy review raised interest rates for the sixth
consecutive time since mid-March 2010, with an objective to control inflationary
expectations. The RBI raised the repo and reverse repo rates by 25bp each to 6.25%
and 5.25%, respectively.
Liquidity management in the near term
The Central Bank maintained status quo on the cash reserve ratio (CRR) at 6.0% in
light of the sharp liquidity crunch in the banking system, indicating that it would look
to manage the liquidity situation in the coming days.
We believe if forex inflows continue at the same pace, looking at the current account
deficit and the need to avoid further rupee appreciation, we believe the RBI's intervention
would be required. Such intervention would also help relieve the liquidity situation,
further aided by government spending returning some liquidity to the system in the
near term.
Indicated pause in rate hikes not a sign of easing stance
The RBI also indicated that a further rate hike was unlikely over the next three months.
In our view, this is because the RBI may be partly taking cognizance of the increasing
interest differential vis-à-vis major developed economies and the tight liquidity situation,
thus ensuring an upward bias to broader interest rates. Once liquidity normalises, the
RBI may choose to use the CRR tool if forex inflows start creating excess liquidity, or it
may choose to use rate hikes again. In any case, in our view, the RBI's indications in
the current policy should not be construed as an easing in the monetary stance.
Considering the ongoing upcycle in the economy, we believe demand-led inflationary
expectations are likely to remain a worry for the RBI, necessitating a calibrated monetary
tightening stance
Prudential measures in respect of housing loans
The RBI also proposed the following changes in the rules of housing loans:
Loan-to-value (LTV) ratio in home loans must not exceed 80%, in order to curb
excessive leveraging
Risk weight for home loans above `75lakhs to be at 125%
Standard asset provisioning for teaser home loans increased to 2% due to concerns
on teaser rate home loan schemes
Deregulation of interest rate on savings bank deposits
The RBI has proposed to prepare a discussion paper by the end of December 2010
that will delineate the pros and cons of deregulating the interest rate of savings bank
deposits. In our view, one of the problems with deregulating savings rates is the
interest-rate ALM mismatches that could arise if the savings rate is deregulated,
considering the regulatory requirements for Indian banks to invest 25% of their NDTL
in fixed-rate government bonds.
Other takeaways
WPI inflation targeted at 5.5% by March 2011, as per the new series
FY2011 non-food credit growth projection remains unchanged at 20%
FY2011 GDP growth projection remains unchanged at 8.5%
Draft guidelines on new bank licences by end-January 2011
Discussion paper on foreign bank presence in its final stages
RBI's policy stance
RBI's policy stance for the remaining period of FY2011 has been conditioned by the
following three major considerations:
First, the domestic economy is on a strong footing. The 8.8% GDP growth for
1QFY2011 suggests the economy is steadily regaining the pre-crisis growth trajectory.
Although uncertainty persists with regard to global recovery, India's domestic growth
drivers are robust, which should help absorb, to a large extent, the negative impact of
a slowdown in global recovery.
Second, inflation remains high. Both demand-side and supply-side factors are
at play. Inflationary expectations also remain at an elevated level. Given the spread
and persistence of inflation, demand-side inflationary pressures need to be contained
and inflationary expectations anchored.
Third, even though a liquidity deficit is consistent with an anti-inflation stance,
excessive deficiency can be disruptive both to financial markets and to credit growth in
the banking system. To ensure that economic activity is not disrupted by liquidity
constraints, liquidity deficit needs to be contained within a reasonable limit.
Against the above-stated backdrop, the RBI expects the stance of monetary policy to:
Contain inflation and anchor inflationary expectations, while being prepared to
respond to any further build-up of inflationary pressures
Maintain an interest rate regime consistent with price, output and financial stability
Actively manage liquidity to ensure that it remains broadly in balance, with neither
a surplus diluting monetary transmission nor a deficit choking off fund flows.
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