Wednesday, October 28, 2009

The days of easy money may fade

RBI's Exit:

Reserve Bank governor Duvvuri Subbarao on Tuesday ended the soft monetary policy aimed at easing credit crisis last year as he began the exit by withdrawing liquidity boosting measures, becoming the third central banker in the world to do so after Australia and Israel.

This makes increase in lending rates imminent next quarter if consumer and asset prices remain high. He left key policy rates unchanged.

Exit of an easy money policy:

The governor withdrew a special facility making available funds from banks to mutual funds and finance companies, made it more expensive to lend to commercial real estate, forced banks to invest more in government bonds and asked lenders to set more funds for bad loans. The special facility was introduced last year to boost liquidity for firms in the financial sector after the credit markets froze.

But the RBI surprised the market in its choice of instrument to announce the exit of an easy money policy. The statutory liquidity ratio (SLR), which prescribes the percentage of deposits that banks are required to invest in government debt, has been raised to 25% from 24%, which Mr Subbarao said was a reversal of an exceptional measure.

Last year, at the height of the global credit crisis, the central bank had lowered the SLR to ease credit flow to industry.

RBI: Alarmed and Reassured:

RBI has introduced curbs on securitising loans and has announced a stress test for all banks next year.

While the governor was alarmed with the secular rise in prices of all asset classes, real estate, equities, gold and commodities, resurgent foreign portfolio, or FII flows of $14 billion in the first seven months appears to have reassured him that recovery will not be hit.

Lending to real estate:

The fact that year-on-year bank lending to real estate has grown 43% as on end-August had already sparked speculation that the RBI may act on these loans. As Mr Subbarao said, although the amount of credit to real estate is not very high, it has been the fastest growing.

By choosing to increase the extent of standard provisions that banks need to make on real estate loans, the RBI has discouraged fresh loans, yet at the same time has ensured that the capital adequacy ratio is not hit because of existing loans.

Managing the recovery:

The RBI has said that it expects activity in the service sector to grow with a lag and it also points out that inflation has returned to positive territory earlier than expected. The governor pointed out that the upside risks have already materialised. Attention has shifted from managing the crisis to managing the recovery.

To read more, please, visit The Economic Times

Related Story:

Interest rates set to rise, signals RBI

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