Subbarao puts onus on Govt

Slash in CRR may be RBIs Curtain-Raiser to Rate Cuts

Higher-than-expected 50-bps cut in cash reserve requirement raises hopes of cheaper loans, but guv says lower rates will depend on govts efforts to rein in fiscal deficit OUR BUREAU MUMBAI

Industry and consumers can look forward to lower cost of funds for the first time in two years after the Reserve Bank of India cut the cash reserve requirement of banks, likely to be the precursor to interest rate cuts later this year. But using unusually blunt language, Governor Duvvuri Subbarao made it clear that lower rates will depend on the government taking credible steps to rein in fiscal deficit. In the absence of credible fiscal consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending, said Subbarao. The forthcoming Union Budget must exploit the opportunity to begin this process in a credible and sustainable way. The pace of decline in borrowing costs is thus likely to be slower and punctuated unlike 2008, when the RBI cut rates 4.25 percentage points in 10 months after the credit crisis in 2008, as the possibility of resurgence in inflation, high government borrowings and a weak rupee could destabilise the economy. The biggest and immediate beneficiary of a 50-basis-point cut in the cash reserve ratio (CRR) will be the government as yields fall. But if unbridled borrowing by the state continues, it could nullify monetary efforts to revive economic growth. Investors cheered the policy reversal that brought CRR down to 5.5%, which will release 32,000 crore into the system. The benchmark Sensex rose 1.6% to 16.995.77 and the rupee was firm. But bond yields jumped to 8.35%, from 8.17%, on speculation that open market operations (OMO), the oxygen that kept the banking system flush with liquidity, could be discontinued after the CRR cut. Growth Estimate Lowered to 7% Repo, the rate at which the central bank lends to banks, has been retained at 8.5%. Reverse repo, the rate it pays banks for parking surplus funds with it, and the marginal standing facility remain unchanged. The reduction can also be viewed as a reinforcement of the guidance that future rate

actions will be towards lowering them, the governor said in his review. It is difficult to determine the pace, timing and magnitude of the reduction, as government finances and suppressed inflation are wild cards. Subbarao, who stuck to his anti-inflationary stance despite falling industrial output and calls for an interest rate cut for nearly six months, lowered the economic growth estimate for fiscal 2012 to 7%, from 7.6%. But he left the inflation forecast at 7% as prices of inputs such as diesel had been held down by administrative action, which combined with a weak rupee could stoke prices again. We dont think there is sufficient time between now and March 15 to produce a sufficient degree of comfort regarding inflation, said Gunit Chadha, CEO, Deutsche Bank India. If liquidity tightness persists, there may well be further CRR cuts in March, but we think the first rate cut in this cycle would only come in April. Finance Minister Pranab Mukherjee may overshoot his target of borrowing for the fiscal, which has been twice revised upwards, as slower economic growth upsets revenue calculations and a weak stock market makes the Rs 40,000-crore disinvestment target unachievable. If borrowing remains high, rate cuts may take longer. The government raised its borrowing limit by Rs 93,000 crore to Rs 5.1 lakh crore this fiscal, which could take fiscal deficit to more than 5.5% of the gross domestic product that is considered high. About 83% of revised gross and 80% net market borrowings were raised by January 16, leaving room for speculation that the limit may be breached. A repo rate cut in March looks unlikely, says Sonal Varma, economist at Nomura. The RBI stated that rate cuts will be conditional on a sustainable moderation in inflation and strong signs of fiscal consolidation. With the Union budget due around mid-March and core inflation likely to ease substantially only in March, we believe that the first repo rate cut is likely on April 17. The Wholesale Price Index could start climbing after falling to a two-year low mainly due to seasonal factors such as vegetable prices. Manufacturing index is still rising at 7.7%, though it is down from 8.1% in October. Crude oil prices remain high and the fall in prices of other agricultural commodities could also be short-lived due to easy monetary policies in the developed markets where rates are just about 1%. Supply limitations and continued ultra-accommodative monetary policies in major advanced economies pose upside risks to commodity prices in 2012, said the governor. Currency depreciation witnessed in the second half of 2011 and the lagged

passthrough to domestic prices could also add to inflationary pressures. The next mid-quarter review of monetary policy will be announced on March 15 and for the next fiscal on April 17.