The first big message from this credit policy is the clear and firm reiteration of the 6% inflation target by the RBI. The second would be the continuing reduction in Statutory Liquidity Ratio (SLR) preemptions as well as the Held to Maturity (HTM) reductions.
The implications of the 6% target are significant. First, it anchors market expectations that rate actions would be dependent on CPI inflation reaching this number on a sustainable basis. This would mean that inflation data will be critical in determining the rate path. In our view, a significant part of this inflation is indeed from the food component and how government addresses this will have a major bearing on the overall number.
The initial actions of the new government seem to suggest a commitment to low inflation and fiscal consolidation. A moderate 2% increase in MSP, reform of the APMC system, listing of certain crucial vegetables as essential commodities are all steps in the right direction. However, taking these to conclusion in terms of effecting a price decline will be critical to how rate policy works out. Equally pertinent is the fact that global oil prices have been stable and under-recoveries related to diesel are minimal, which will ease the pressure of fuel inflation going forward. This should support lower inflation, barring global disturbances.
The second big change relating to SLR has many ramifications and implications. First of all it is against the backdrop of convergence with a sharp increase in liquidity requirements for banks globally under the Basel framework. This SLR reduction will help with the otherwise stiff liquidity preemption that this global framework will impose. The reduction in HTM however will have an eventual impact on moderating bank demand for long bonds. This demand reduction will need to be matched by government action in terms of fiscal consolidation towards the 3% target.
One area on which the policy did not comment, was the current volatility in call rates due to fluctuations in liquidity.
There have been, in the recent past, a number of days where the call rate moved by more than 1%. Apart from this, the rate itself also remained sticky at the upper end of the corridor for extended periods of time in July. In this regard, the RBI subsequently clarified that indeed they would focus on smoothening call-rate volatility and would look at various measures to do so. This would be a welcome development.
In conclusion, the 6% inflation target sets the stage for rates to remain at current levels unless there is a sharp decline in the current inflation trajectory. This will largely depend on government?s food inflation-related actions bearing fruit. The SLR reduction will need to be balanced with credit growth needs of the country and the smooth transitioning to the new global liquidity norms. But for sustained reduction in such SLR/HTM norms, a concerted commitment by government to fiscal targets will be needed to maintain the right market balance.
Shilpa Kumar
(The writer is SGM and head of global markets group at ICICI Bank)
