The balancing act by RBI governor D Subbarao included raising the percentage of deposits that banks compulsorily park with it to 25%a 100-basis point rise. To prevent an asset bubble in the commercial real estate sector, it has asked banks to set aside more funds as cover for loans.
The governors statement said the measures constitute the first phase of exit from the special liquidity support measures that were taken to cushion the domestic economy from the impact of the global financial meltdown that began in September 2008.
While RBI did not alter key interest rates, industry read the signs. CII president Venu Srinivasan said any tightening of monetary policy in the near term would be counterproductive.
In the G-20 league, India now becomes the second country after Australia to take steps that will raise borrowing costs. In his detailed explanation for doing so, Subbarao said India faced a different environment from the advanced economies, as also other emerging market economies.
According to him, these countries do not face an immediate risk of inflation, unlike India. The bank has raised its estimate for year-end inflation to 6.5% from the earlier projection of 5%. It said India is also one of the few large emerging economies with twin deficitsfiscal and currentthat could hamper a recovery unless corralled.
RBI has injected about Rs 5.85 lakh crore in cash since September 2008 as additional liquidity support for the Indian economy. In an interview with FE, Subbarao said exit from this support has become a central issue in our policy matrix.
But even now, the raising of the statutory liquidity ratio will only revert to the normal stage that prevailed pre-crisis, he said. As banks currently maintain SLR investments at 27.6 % of their net demand and time deposits, the increase will not impact the liquidity position of the banking system and credit to the private sector, Subbaro argued.
Among the measures announced by RBI is clubbing the liabilities of scheduled banks arising from transactions in collateralised borrowing & lending obligation in their cash reserve ratio, a percentage of which is impounded by RBI. RBI has also closed two refinance windows, which were created to meet the needs of non-banking finance companies and mutual funds during the crisis period. The limit under the export credit refinance facility, which was raised to 50% of eligible outstanding export credit, is also being returned to the pre-crisis level of 15%.
With stability in financial markets, RBI also decided to undertake major reforms in currency futures by permitting stock exchanges to offer more than dollar-rupee contracts. They can now offer euro-rupee, yen-rupee and pound sterling-rupee currency pairs, too. It has also decided to issue final guidelines for repo in corporate bonds by end-November.
The other major step that RBI signalled on Tuesday was to introduce plain vanilla over-the-counter single-name corporate default swaps for corporate bonds. The CDSs will be on offer only to resident Indians. To begin with, all CDS trades will be required to be reported to a centralised trading platform and in due course will be brought on a central clearing platform.
The governor said the challenge for RBI is to support the recovery process without compromising price stability. On current assessment, the growth projection for GDP for 2009-10 has been retained at 6% with an upward bias, unaltered from that made in the July review. This assumes a modest decline in agricultural production, as the southwest monsoon rainfall this year has been the weakest since 1972, affecting both yield and acreage of agricultural crops, but a faster recovery in industrial production, he explained.
Banks are urged once again to step up their efforts towards credit expansion while preserving credit quality, which is critical for (the) revival of growth, Subbarao said.