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Indian monetary policy 2009-10 second quarter review

Contributed by Nirmal Bang

By Nirmal Bang

Statutory liquidity ratio increased by 100 basis point
The Reserve Bank of India (RBI) increased statutory liquidity ratio by 100 basis point from 24% to 25 %, effective from November 8, 2009. SCBs (scheduled commercial banks) are currently maintaining SLR investments at 27.6% of their Net Demand Time Liability (NDTL); as such the increase in SLR will not impact the liquidity position of the banking system and credit to private sector. Meanwhile CRR, repo and reverse repo rates have been left unchanged.

GDP Growth forecasted lower at 6%
The central bank cut is growth estimate for 2009/10, to 6% from 6.5% with an upside bias. The main reason for this has been the south-west monsoon rainfall this year which has been the weakest since 1972 affecting both yield and acreage of agriculture crops. This has impacted the kharif production and over all the agriculture production in 2009-10 is expected to be lower than last year.

Credit & Deposit growth revised downwards
During the year (upto Oct 9, 2009) deposits grew by 20% while credit growth was significantly lower at 10.8%. Going forward, RBI has projected deposits to grow by 18% as compared to 20% set out in first quarter review. In 2009-10, credit expanded by Rs.1,14,800 crore, while in order to achieve a projected a growth of 20% banks will need to expand credit by Rs.4,40,00 crore in the remaining part of the year, which is highly unlikely.

RBI has projected WPI inflation at around 6.5% per cent by end-March 2010
Keeping in view the global trend in commodity prices and domestic demand -supply, the baseline projection for WPI inflation at the end ?CMarch 2010 is placed at 6.5% with an upside bias as compared to 5% projected in the first Quarter review.

Banks must keep at least 70% provision coverage ratio
With a view to improve the safety of banking sector, RBI has advised banks to increase the provisioning cover and enhance the financial soundness. RBI has indicated a provisioning coverage ratio of not less than 70% including the specific and floating provisions. Banks should achieve this norm by end of September 2010. We conclude that this move will impact the performance of banks which have lower coverage including SBI (currently at 45%), Canara Bank (28%), and ICICI Bank (52%) based on the latest reported figures.

However, financial institutions including Axis Bank, HDFC Bank, and Federal Bank have a provision coverage ratio of more than
70%. Therefore, banks with higher coverage ratio will not be impacted by the increase in provision coverage ratio.

Banks provisions for commercial realty sector increased
In view of large increase in credit to commercial real estate last year (Rs 28353 crore) and extent of restructured advances in this sector, RBI has increased the provisioning requirement for advances to the commercial real estate sector from present level of 0.4% to 1%.

Lock in period for Securitization Exposures
To ensure that originators do not compromise on due diligence of assets generated for securitization, RBI has proposed a minimum lock of one year period for all types of loan before these loans can be securitized and the minimum retention by the originators will be 10% of the pool of assets being securitized.

Export credit refinance lowered to pre-crisis level
RBI has lowered the export credit refinance limit which was increased to 50% of eligible outstanding export credit back to pre-crisis level of 15%. In addition, the special refinance facility and special term repo facility for the SCBs are being discontinued from immediate effect.

RBI has kept HTM category limits unchanged.
RBI has maintained the HTM ratio (limit of SLR which banks can shift in HTM category) at 25%.

Conclusion
Increase in SLR signals that the central bank is keen to suck out excessive liquidity from the financial system in order to avoid formation of any asset bubble. In addition, RBI is emphasizing on price stability to keep inflation under control. Consequently, we anticipate RBI to tighten liquidity in the coming quarters through rise in CRR. Along with the above mentioned points, RBI is keen to increase stability of Indian financial system by adopting appropriate risk management measures which is indicated from change in the provisioning norms.