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On 16 september, reserve bank of india (RBI) Governor D. Subbarao announced a liquidity enhancement measure. Usually, banks avail of liquidity support on securities with the central bank in excess of the statutory liquidity ratio (SLR) of 25 per cent. Now, Subbarao has allowed banks to avail additional liquidity up to 1 per cent of their deposits and market borrowings. The move is temporary, and effectively amounts to a cut in the SLR. With inflation also moderating slightly from a high of 12.63 per cent, will Rao opt for a status quo on key rates?
Says Tushar Poddar, vice-president for Asia Economics Research at Goldman Sachs, “The RBI’s steps to ease liquidity are a significant change in policy as it increased the cash reserve ratio (CRR) by 150 basis points (bps) and the repo rate by 125 bps since April.” Former RBI Governor Y.V. Reddy never once made a liquidity infusing move during his five-year stint.
Rohini Malkani, economist at Citigroup (India), is more bullish. “There could be a further relaxation of norms on the capital account, both NRI and cross-border borrowing, and continued buoyancy in both credit and deposits,” she says. “And the consequent demand for government securities to meet SLR raises the possibility of an SLR cut. Lower commodity prices and stabilising inflationary expectations raise the odds of the RBI keeping rates on hold.”
Of late, the 10-year benchmark yield has been easing — from 8.48 per cent to 8.34 per cent last week, but higher than the intra-week low of 8.27 per cent. This, and the recent dip in inflation, had fuelled speculation that interest rates may have peaked. The counter view is that it was due to demand to meet the SLR requirements. Tight liquidity saw corporate bonds ending flat with the five-year yield at 10.95 per cent; and credit spreads between the five G-Sec and triple-A rated papers widened to 243 bps from 221 bps.
The dip in G-Sec yields is good news for banks. There could be a mark-to-market reversal in the case of state-run banks. ‘Big daddy’ State Bank of India will gain hugely on account of the special securities issued to it by the Centre as consideration for capital when the RBI’s 56 per cent stake was transferred. The flip side is that part of this potential gain will be reduced by the provisioning mandated by RBI on the farm-loan waiver.
But it is still early to say if banks will cut interest rates soon. “Banks may surprise in terms of their reported last quarter 2008 earnings owing to lower investment hits and lower credit costs,” says Rajeev Varma of Merrill Lynch. “But both top line and pre-provision profits could disappoint, especially for state-run banks. Bank margins will be under pressure quarter-on-quarter on lower loan yields, owing to lending rate cuts being undertaken in mid-February this year.”
Several banks have been offering higher rates on fixed deposit; and some of them have seen an erosion of cheaper current and savings account deposits. But banks may be at the receiving end of slower loan growth via higher incidence in non-performing assets and loan restructuring. “Benign credit conditions in the past, rapid growth rate in credit in recent times and outsized impact of increase in credit costs on banks’ earnings prompt us to focus on asset quality issues as key factors affecting banks’ earnings prospects,” says Goldman Sachs in a recent report.
The good news is that recent statements on inflation have all been positive. On 17 September, Prime Minister Manmohan Singh, himself a former central bank chief, said: “There are signs of moderation in the high inflation that we have witnessed recently.” Will interest rates soften? Everyone’s trying to talk them down.
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(Businessworld Issue 23-29 Sep 2008)