Raising SLR is a timely move considering excess liquidity, large govt borrowing plans

Written by Meera Sanyal | Updated: Oct 31 2009, 04:39am hrs
In the half yearly review of the monetary policy, the RBIs key message is that it is time to prepare for a withdrawal from the extraordinary monetary stimulus provided in the aftermath of the global financial crisis last year. Considering the dilemma it faces between choosing to curb inflation or support growth, the RBI has decided to adopt a wait and watch approach by keeping policy rates unchanged. But as the RBI has demonstrated in the past, it will respond swiftly as its policy dilemma is resolved.

Recognising that the WPI-based inflation could be much higher than it had earlier anticipated, the RBI has raised its end-March 2010 inflation forecast to 6.5% with an upward bias. Its concerns on the economic recovery process are visible too, considering that it has retained its growth forecast of 6% for this fiscal year.

The choice of raising the SLR by 1% is a timely move considering the excess liquidity conditions and large government borrowings programme. Higher SLR requirement would help improve the appetite for government bonds and will also help reduce the excess liquidity within the banking system, as a smaller proportion of securities will be available to banks for repo transactions with the RBI.

The tone of the policy statement is fairly hawkish, which suggests that the Indian central bank will start to exit from its accommodative monetary stance, as soon as the growth conditions improve. We are yet to see significant improvement in the traditional growth driversprivate consumption and investment demand.

Evidence available so far does suggest that domestic consumption improved during the second quarter of the current fiscal. Any pick-up in private consumption would bolster the case for monetary tightening.

The RBI has also given clear indications that it would act soon to tackle the rising inflationary pressures. Policy rates hikes could still be two quarters away. The RBI would first look to withdraw liquidity from the banking system with a CRR hike, perhaps before the end of 2009 itself. Improving capital inflows make the case for a CRR hike even more compelling.

On the market development side, efforts to develop the derivatives market for credit and currency are welcome. The cause of financial inclusion has also been furthered by widening the scope of business correspondent model.

The writer is country executive, ABN AMRO NV