RBI Policy- No surprises on the rate front, stiffer norms for banks

In a complex economic environment, we look up to the erudite to give us direction, perspective and knowhow of the situation we find so difficult to comprehend; difficult because of conflicting information flow and sometimes on account of too much of information. The monetary policy review which was announced on 27th October was much awaited by markets for the same reasons.

The tone of the policy statement has shifted to hawkish from a soft stance adopted during the recession. The focus has clearly been on supporting economic growth, ensuring price stability by anchoring inflation and strengthening the banking sector that was responsible for the financial crisis which then blew up into a full-fledged economic crisis.

Globally the economic scenario is improving and India too is seeing recovery as is indicated from the IIP numbers and improvement in the business confidence index is what the RBI maintains. But the RBI has just stopped short of announcing a rate hike because export growth is still in the negative territory and it does not want to hamper economic growth which has gradually begun to take off. A premature exit would hamper all the good work done over the past several months but at the same time a delayed exit would lead to spiralling inflation. So RBI has decided to exit in a calibrated manner.

The special liquidity support measures have been withdrawn. They include the limit for export credit refinance facility and the non standard refinance facilities.

To contain inflation, the liquidity lever is being tightened. Capital flows into the country have increased significantly over the last 9 months (increase in rates would have increased the flows on account of interest rate differential) and the average daily amount absorbed by the Reserve Bank under the LAF window was to the tune of Rs.1,20,000 crore indicating that there is ample liquidity in the system. The RBI has thus increased the SLR to 25 percent from the 24 percent level. That will reduce some amount of liquidity in the hands of the banks. This should have a minimal impact on banks because currently the SLR they are maintaining is in excess of the threshold limit set and currently there is ample amount of liquidity in the system.

Caution and prudence in policy making always follow a financial crisis. To the credit of RBI, the Indian banking system has remained almost unscathed in the current crisis purely because of caution exercised by the RBI which most of us were critical of at that time. But in hindsight, it has proved to be the best thing that could have happened to the banking sector.

The RBI continues to work towards its goal of further strengthening the banking sector by undertaking a slew of measures.
Provisioning requirement for standard loans to the commercial real estate sector has been increased to 1 percent from 0.4 percent. This is done because loans to this sector was growing at a fast pace and the RBI wanted to tackle asset inflation. The short term impact would be seen on the bottom line of banks. The cost of funds to the developers will increase which in turn would result higher cost to buyers.
Increase in the provisioning coverage ratio to 70 percent by September 2010 will affect banks profitability as they will have to set aside funds to meet this new stipulation.
Lock in period and minimum retention has been introduced for securitisation exposures so as to ensure that proper due-diligence is done by originators.

The ground has already been set for monetary tightening with the current policy document stating unequivocally that there is a shift from managing the crisis to managing the recovery. As growth comes back on track with some amount of certainty, the RBI will act swiftly and tighten interest rates. I do not expect this to happen till early next year. In the interim, expect RBI to continue to introduce measures to strengthen the banking system in line with global counterparts.