The Reserve Bank of India (RBI) could soon be slashing the statutory liquidity ratio (SLR) for banks. At present, the central bank has pegged the key ratio — the proportion of liquid assets to demand and time liabilities — at 25 per cent. Speculation has been rife for some time in banking circles that such a move is likely in the second half of the current financial year.

Ever since the Centre approved the lowering of the SLR floor from the present levels early this calendar, market watchers have argued that it is more a question of timing rather than whether such a move will happen or not. The catch was that as inflation was rearing its head at 6 per cent, an SLR cut would have gone against the RBI measures to control money supply. Significantly, when he was asked last month if an SLR cut was imminent, Y.V. Reddy, the Reserve Bank governor, objected only to the word ‘imminent’. “I don’t agree with the word imminent, it is market moving, but yes, as soon as the situation is appropriate, we will cut SLR,” said Y.V. Reddy, governor, RBI. Now, with inflation under control, that the time has begun to look appropriate.

There is yet another reason why the move could come soon. Banks’ investment in government and other approved securities declined from 31.4 per cent in March 2006 to 28 per cent in March 2007. And several banks are now operating their SLR at close to the minimum level. This happened as banks liquidated their holdings of these securities to extend credit. Now, if banks were to maintain the SLR at a minimum of 25 per cent, there would not be enough government securities to invest in. RBI estimates that bank deposits will grow by Rs 4,90,000 crore in 2007-08. With SLR at 25 per cent, banks would have to buy government bonds worth Rs1,22,000 crore. However, with the the Centre slated to issue just Rs 1,09,000 crore in new bonds, it would leave them with a a shortfall of Rs 13,000 crore.

So, when will the situation be ‘appropriate’? Some believe that could be as early as next month. Particularly since Rs 28,000 crore of bonds will go out of the system by then. Banks will have to rush to buy fresh ones from the market resulted in distorted bond prices and an even more distorted interest rate curve.