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Inside the money-macro story

HT takes a look at the central bank’s move to keep interest rates unchanged while its focus stays on inflation worries.

india Updated: Jul 31, 2012 23:37 IST
Gaurav Choudhury

Caught between rising prices and sliding growth, the Reserve Bank of India (RBI) on Tuesday maintained a status-quo on key rates. HT explains the nuances of the growth-price-interest rate interplay.







What has the RBI done?

It has kept the cash reserve ratio (CRR), the repo rate and reverse repo rate unchanged, but cut the statutory liquidity ratio (SLR) to 23% from 24%.



What is CRR?

CRR is the proportion of deposits banks have to park with the central bank. It currently stands at 4.75%. http://www.hindustantimes.com/Images/Popup/2012/8/01_08_biz2.jpg



What is SLR?

Apart from keeping a portion of deposits with the RBI as cash, banks are also required to maintain a minimum percentage of their deposits with them at the end of every business day, in the form of gold, cash, government bonds or other approved securities. This minimum percentage, which has been cut to 23%, is called SLR. CRR is maintained in cash form with RBI, whereas SLR is maintained in liquid form with banks themselves. To meet SLR, banks can use cash, gold or approved government securities.



What does a SLR cut aim to achieve?

A cut in SLR allows banks to unlock funds for lending which they had set aside in government securities and loans. According to estimates, a one percentage point cut in SLR will allow banks an additional Rs 60,000 crore to lend.

What is repo rate?
It is the rate at which the RBI lends to banks.

How does repo rate influence interest rates that banks charge from customers?
A lower repo reduces banks’ borrowing costs goading them to cut interest rates for final home, auto and corporate borrowers.

Does a reduction in SLR reduce borrowing rates for customers? http://www.hindustantimes.com/Images/Popup/2012/8/01_08_biz3.jpg

Maybe in a very indirect way. With more cash in hand to lend following the cut in SLR, banks may not need to woo customers by offering higher interest rates to shore up their deposit base. Some banks may even consider lowering the interest they pay to customers on their fixed and savings deposits to cut costs. Lower costs, in turn, could prompt them to reduce their final lending rates

What are policy rates?
The policy rate acts as the guide for final lending rates that banks charge from borrowers. In tight liquidity situations, the repo rate acts as the policy rate. In situations of excess liquidity, when banks park money with the RBI from their pool of lendable resources, the reverse repo rate acts as the policy rate.

Till October, the RBI had raised the repo rate 13 times in 19 months to tame prices. A higher repo would raise banks’ borrowing costs, which in turn would raise interest rate on final home, auto and corporate loans. A higher reverse repo would give banks incentive to park money with RBI, reducing liquidity and demand. A higher reverse repo means it would suck cash from the system to stymie demand and cool prices.

What prompted the RBI to maintain a status quo on policy rates?
A patchy monsoon is likely to trim food output and hits farm income, which supports a two-third of Indians, or about 800 million people. Rural spending on most items — from television sets to gold — goes up with adequate rains and farm output.

High prices essentially shrink household incomes, as middle-class Indians have to spend much more for the same amount of goods. Since 2009-10 food price shocks could not be controlled in time, they spread into what economists call “core inflation”, or prices of non-food and non-fuel commodities.

India’s retail prices are already high. On a year-on-year basis in June, vegetable prices rose the sharpest at 28%, while milk and allied products shot up 13.2%. This has dissuaded the RBI to slash interest rates to suppress prices. Currently, high interest rates have made borrowing costlier for firms.