RBI May Have To Delay SLR Reduction

The liquidity surplus in the banking system is likely to force the Reserve Bank (RBI) to delay a cut in the statutory liquidity ratio (SLR) for banks.

The SLR is a ratio (fixed by the central bank) of the total demand and time liabilities that a bank has to maintain in the form of cash, gold or approved securities with the RBI.

A specially announced ordinance last year gave the central bank the power to cut the SLR from the existing 25 per cent. Analysts had expected a SLR cut in the second half of 2007-08.

Though its original purpose of funding government borrowing has lost relevance due to increased fiscal discipline and the growth of other (non-bank) investors such as insurance and gilt funds, the importance of SLR as a regulatory tool has increased now as the RBI is struggling to reign in liquidity.

DSP Merrill Lynch India economist Indranil Sengupta sees the current minimum threshold of 25 per cent SLR as the key to the success of the central bank's market stabilisation scheme (MSS) bond auctions.

Sengupta expects the RBI to postpone SLR cuts to the second half of 2008-09 - Merrill Lynch expects a 3 per cent cut.

The RBI has been using the MSS auction to drain out excess cash from the system and rein in inflationary pressures. It has hiked the ceiling four times in this financial year - to Rs 2,00,000 crore - to suck out extra money generated by its dollar buying (and rupee sales) in the forex market.

"The current 25 per cent SLR forces banks to buy MSS to fulfil gilt requirements. With $40 billion already bought by the RBI (to curb the rupee rise) in FY08, the central bank is unlikely to take chances with sterilisation," Sengupta wrote in a report titled 'reworking the SLR math' on Friday.

"At the heart of the India growth story is the ability of banks to extend credit (funding growth) without deposit mobilisation (avoiding inflation). Surplus gilts (beyond 25 per cent) allowed banks to fund the loan book by drawing down the gilt portfolio. Sustained credit offtake is putting an end to this rebalancing," Sengupta said.

Credit growth has slowed to 23.3 per cent from 28.8 per cent while deposits have picked up to 24.9 per cent from 20.4 per cent, latest figures from the RBI show. Economists say that though low credit growth suits the aim of the central bank to keep inflation low, going forward SLR will have to be cut to push up credit.

Abheek Barua, chief economist, HDFC Bank, said, "Currently credit is under some kind of a crisis but, with banks cutting lending rates, the RBI will have to accommodate around 25 per cent credit growth and a 22 per cent deposit growth."

In other words, RBI will have to free up some capital by cutting SLR to support credit and through it economic growth next year.

However, it will also depend on how the liquidity situation pans out. Samiran Chakraborty, chief economist, ICICI Bank said, "As long as excess external flows remain SLR cut will be delayed. Liquidity is the most important challenge at present."