The Reserve Bank of India has decided to make the repo rate the centerpiece of its monetary policy even as it raised the key benchmark rate by a higher-than-expected 50 basis points to 7.25 per cent as part of an aggressive inflation-busting strategy.
Governor Duvvuri Subbarao seemed to abandon the earlier nuanced position of carefully balancing the compulsions of quelling raging inflation through rate increases with the imperatives of accelerating the pace of growth in the world’s second-fastest economy.
The task of bringing down inflation should take precedence “even at the cost of some growth in the short term”, the RBI said in its latest monetary policy statement.
“The objective is to bring down inflation to somewhere between 4 per cent and 4.5 per cent. In the medium term, we would like to take it down to 3 per cent,” he said.
The RBI governor forecast a GDP growth of 8 per cent for this fiscal with inflation projected at 6 per cent with an upside bias.
The 8 per cent GDP forecast casts doubts on the government’s projections of 9 per cent this year. Moreover, the 8 per cent growth forecast assumes a normal monsoon and global crude oil prices at $110 a barrel.
The sharp 50-basis-point increase in the repo rate seemed to catch bankers and the markets off guard. “If you are referring to 25 basis points as a baby step, then yes, this is no longer a baby step,” Subbarao said in response to a question raised at a press conference later in the day.
The mandarins of Mint Road showed unexpected alacrity in overhauling the monetary policy template by picking up several elements from the report of a working group headed by RBI executive director Deepak Mohanty that was submitted less than 50 days ago.
Governor Subbarao accepted the Mohanty panel’s suggestion that the repo should be the only rate-signalling device of the monetary policy.
“The transition to a single independently varying policy rate is expected to more accurately signal the monetary policy stance,” the RBI said.
It also decided to fix the reverse repo rate at 100 basis points below the repo at 6.25 per cent. This makes the repo the only variable rate in the monetary policy. The reverse repo will move in tandem with it and will always rule 100 basis points below it.
The spread between the repo and reverse repo narrowed to 100 basis points on September 16 last year from 125 basis points earlier.
The Mohanty panel — which was set up in September to suggest ways to overhaul the process of monetary policy formulation — had recommended that the moribund bank rate should be reactivated as a discount rate and could form the “upper bound in the rate corridor”.
The bank rate has been stuck at 6 per cent since March 2004.
The Mohanty committee had suggested a rate corridor of 150 basis points with the bank rate ruling 50 basis points higher than the repo.
The RBI widened the corridor to 200 basis points by creating a new marginal standing facility (MSF). This will give banks a new window from which they can borrow overnight funds up to 1 per cent of their net demand and time liabilities. The Mohanty panel had suggested something very similar and had called it an exceptional standing facility.
The MSF rate has been fixed at 100 basis points above the repo rate at 8.25 per cent.
Subbarao said there were some problems with refashioning the bank rate as a discount rate.
“There are legal problems and some other interest rates are linked to the bank rate. One option is to resolve the legal issues and delink the interest rates,” he added. “The bank rate will stay for now and later we will link it to something else.”
The central bank also said the weighted average overnight call money rate would be the operating target of the monetary policy. This rate currently hovers at 6.44 per cent.
Tighter provisioning
The biggest beef for bankers was over the sudden decision to tighten provisioning norms for certain categories of advances. Last December, the banks were advised to achieve a provisioning coverage ratio of 70 per cent — which had upset banks such as the SBI.
The RBI has now said that advances classified as sub-standard assets will attract a provision of 15 per cent against 10 per cent earlier. The unsecured exposure of a sub-standard asset will attract an additional provision of 10 per cent. This means the total exposure on these assets will rise to 25 per cent from 20 per cent earlier.
Advances in the doubtful category up to one year will attract a provision of 25 per cent (20 per cent earlier).
The secured portion of advances which have been in the doubtful category for more than one year and up to three years will attract a provision of 40 per cent against 30 per cent earlier.
Restructured accounts classified as standard advances will attract a provision of 2 per cent in the first two years from the date of the restructuring.
The first-quarter monetary policy review is scheduled on July 26.
