RBI’s Mid-Quarter Review of Monetary Policy

The Reserve Bank of India (RBI) in its mid-quarter review of the monetary policy dated 16 December 2010 reduced the Statutory Liquidity Ratio (SLR) by one percentage point to 24 per cent with effect from 18 December 2010. SLR is a portion of deposits that banks park in government securities. RBI’s measure indicated RBI’s intention to release sizeable primary liquidity into the system so as to bring down the liquidity deficit in the system close to the comfort zone of the Reserve Bank. RBI however did not touch the key interest rates as well as warned against a fresh spike in inflation. RBI’s decision to lower SLR will enable banks to sell around Rs 48000 crore from their securities portfolio worth almost Rs 12 lakh crore. The RBI next will conduct open market operation (OMO) auctions for purchase of government securities for an aggregate amount of Rs 48000 crore in the next one month.

RBI has not altered short-term lending (repo) and borrowing rates (reverse repo) to banks that remains unchanged at 6.25 per cent and 5.25 per cent respectively. The cash reverse ratio also remains unchanged at 6 per cent of the banks’ total deposits.

The overall liquidity in the system was in deficit consistent with the policy stance and the extent of tightness has been beyond the comfort level of the Reserve Bank. The situation was caused due to persistence of large government cash balances which have averaged Rs 84000 crore since the second quarter review of November 2010. The large government cash balance situation mirrored in the average net LAF repo amount of Rs 101000 crore. The liquidity deficit was further accentuated by structural factors such as significantly above-trend currency expansion and relatively sluggish growth in bank deposits even as the credit growth accelerated in 2010-11. The RBI is of the opinion that the expansion of the economy has to be complimented with infusion of primary liquidity and the primary liquidity need to provide in a manner consistent with the monetary policy stance. The RBI held that such provision of liquidity should not be considered as a change in the monetary policy stance since inflation continues to remain a major concern.

GDP growth of 8.9 per cent in the second quarter of 2010-11 reinforce the Reserve Bank’s projection of 8.5 per cent for real GDP growth for 2010-11 which will be reviewed in the Third Quarter Review scheduled on 25 January 2011.

Wholesale Price Index (WPI) declined to to 8.8 per cent in August 2010 and further to 7.5 per cent in November 2010 after remaining in double digits in five successive months. The Consumer price (CPI) inflation also slipped to single digit in August 2010. The dip in inflation prompted Reserve Bank’s projection of 5.5 per cent inflation by March 2011.