RBI signals policy tightening, hikes SLR by 100 bps  

October 27, 2009

While keeping all major rates unchanged, the Reserve Bank of India (RBI) restored the statutory liquidity ratio (SLR), the portion of deposits that banks are required to keep in government securities, to 25% from 24% and also discontinued credit refinance facility for exports and scheduled commercial banks. The hike in SLR may suck up more than Rs300 billion from the system.

"The RBI’s move to hike the SLR to 25% is a signal to the start of a tight monetary policy. Given that banks have been parking more than required funds with Government bonds, the hike in SLR is not likely to have an immediate impact on the availability of funds. However, if credit growth picks up in the next quarter, then the impact of SLR hike will start to show up in terms of cost of funds," said Yashika Singh, head, economic analysis, Dun & Bradstreet (D&B).

Echoing the same sentiment, Tushar Poddar, vice president and chief economist, Goldman Sachs India, said, "In our view, the policy statement suggests a hawkish stance and signals that rate hikes are imminent. The RBI has taken the first step in its exit policy by withdrawing special liquidity measures. In our view, it will hike the reverse repo rate at its next policy meeting in January 2010. We expect a cumulative increase in effective policy rates of 300 basis points (bps) in 2010."

In its second quarter monetary policy review, the central bank said liquidity situation has remained comfortable since mid-November 2008 as reflected in the surplus funds being placed by banks daily in the liquidity adjustment facility (LAF) window and so it has restored the SLR for scheduled commercial banks (SCBs) to 25% of their net demand and time liabilities (NTDL).

"Scheduled Commercial Banks (SCBs) are already maintaining SLR investments at 27.6% of their net NDTL. As such, the SLR hike will not impact the liquidity position of the banking system nor the credit availability to the private sector," said Religare Capital Markets Ltd.

RBI left the cash reserve ratio (CRR) unchanged at 5%, the repo and reverse repo rates at 4.75% and 3.25%, respectively. However, according to a brokerage, it sees an imminent CRR hike is likely to begin in late November or early December, to be followed by rate hikes in January and it expects it to go up by 100 basis points till March next year.

The rate sensitive sectors like banking, realty and auto should see a re-rating, as also their earnings estimates going forward. Among autos, the impact would be more pronounced in commercial vehicles followed by two-wheelers and passenger vehicles, Religare added.

The central bank, while retaining its economic growth projection to 6% with upward bias for the current fiscal, has increased its inflation estimate to 6.5% with upward bias by end-March from 5%. Ms Shah of D&B said, "By revising the inflation target to 6.5% from 5%, the RBI has clearly highlighted that inflation will be an area of concern going forward. Calibrating growth and inflation expectations will thus remain high on the RBI’s agenda."

The RBI said that in view of large increase in credit to the commercial real estate sector over the past one year and the extent of restructured advances in this sector, it would be prudent to build a cushion against likely non-performing assets (NPAs). The RBI said it plans to increase the provisioning requirement for advances to the commercial real estate sector classified as ‘standard assets’ to 1% from the present level of 0.4%.

"The directional move has been selective squeezing of liquidity, so that credit availability and hence growth is not stifled across the board. In this regard, the higher provisioning from 0.4% to 1% for commercial real estate (CRE) sector is in order. It is likely to affect companies having high exposure in the commercial segment. The cost of borrowing for the sector may go up on this account. In July, RBI reduced the risk weightage from 150% to 100% on CRE and we believe this may again go up in the future to 150%," said Religare.

While commenting on bank's provisioning coverage ratio, the RBI advised them (banks) to maintain a total provision coverage ratio, including specific provisions as well as floating provisions, of minimum 70% by September 2010.

Sharekhan Ltd said this will impact the profitability of banks with considerably low provision coverage ratio of lower than 50% such as State Bank of India (SBI), ICICI Bank and IDBI Bank since they (these banks) will have to make higher provisions for NPAs. “This will also result in earnings downgrades by the street and we advise shifting out of these banks to large banks with good provision coverage ratio, such as Bank of Baroda, Punjab National Bank and Union Bank of India,” the brokerage added.

RBI said the limit for export credit refinance facility that was raised to 50% of eligible outstanding export credit, is being returned to the pre-crisis level of 15%. The two non-standard refinance facilities, the special refinance facility for scheduled commercial banks and special term repo facility for scheduled commercial banks for funding to mutual funds (MFs), non-banking financial companies (NBFCs), and housing financing companies (HFCs), which was available up to 31 March 2010, are being discontinued with immediate effect, the central bank said.

Earlier in its annual policy review in April, the RBI has provided special term repo facility to SCBs for funding to MFs, NBFCs and HFCs. Since the utilisation of these facilities have been low, the RBI said it decided to discontinue the special term repo facility for scheduled commercial banks for funding MFs, NBFCs and HFCs.

The RBI is also planning to permit currency futures contracts in currency pairs of euro-rupee, Japanese yen-rupee and pound-rupee, in addition to the US dollar-rupee contracts that are already permitted. The combined average daily turnover of the contracts in all the three exchanges increased to $2.5 billion in September from $1.1 billion in March. Market participants have been asking for the permission to trade currency future contracts in other major currency pairs to facilitate direct hedging of their risk in such currencies, the RBI said.

Domestic SCBs, other than regional rural banks, which have been seeking to expand their branch networks, have been allowed to open branches in Tier 3 to Tier 6 centres, identified in the Census 2001, under general permission.
-Yogesh Sapkale [email protected]