What to expect from Raghuram Rajan’s first policy review today

 Raghuram Rajan. Reuters

FP Editors Sep 20, 2013


Today is new RBI Governor Raghuram Rajan’s first monetary policy review. The burden of expectation on Rajan is heavy, particularly after the US Federal Reserve decided to hold off its plans to cut stimulus. Many experts view that the Fed’s unexpected move is giving Rajan enough room to manoeuvre and take a few growth-oriented steps. 

Expectations that Rajan, who had famously predicted the 2008 financial crisis, will bring about a welcome change in the RBI’s functioning have already fired the markets across asset classes.

 Here is a look what are the options for Rajan today: 1) Policy rate: The RBI’s policy rate is the repo rate, which stands at 7.25 percent now. Banks can borrow funds from the central bank daily through the liquidity adjustment facility at this rate. Banks adjust their lending/deposit rates in accordance with the changes affected to this rate. Corporates and banks have raised their pitch for a cut in the policy rate to stimulate the sagging economy. But the RBI may not be in a position to make use of the breathing space provided by the Fed to engineer a cut in policy rate yet.

 2) CRR: CRR is the proportion of deposits banks have to mandatorily keep with the RBI. The ratio now stands at 4 percent. But banks do not know how much they get as deposits on a day. So banks were given a leeway on their daily average as they had meet only 70 percent of their CRR requirement. But the RBI norms mandate that banks need to conform to the 4 percent norm towards the end of the fortnight, when they report their CRR to the RBI. In its bid to squeeze liquidity, the central bank increased the daily average requirement to 99 percent.

 A cut in the CRR will release funds into the banking system. 

The RBI may not be ready to cut the CRR but it may bring down the daily requirement of banks to about 90 percent. This will free up funds and ease liquidity strain on individual banks.

 3) LAF: Liquidity adjustment facility (LAF) is a daily operation by the RBI which helps banks meet their liquidity needs. Banks could borrow funds up to 1 percent of their deposits through this window at a rate of 7.25 percent. As noted earlier, this is the policy rate of the central bank. In its bid to control liquidity the RBI recently capped banks’ borrowing from this window at 0.5 percent of individual bank’s deposits. Rajan may reverse this step, easing the liquidity strain for individual banks. 

4) MSF: Marginal standing facility (MSF) is the window from where banks access funds from the RBI in a dire situation. The rate at this window was 100 basis points above the repo rate. This was increased to 300 basis points, effectively pushing the MSF rate to 10.25 percent as part of the tightening measures. 

With the LAF window also squeezed, banks were forced borrow at higher rates from this window. This had in general pushed up short-term borrowing costs of companies. Experts feel the RBI may well cut this rate to 9.25 or even 8.25 percent, thus signalling a fall in the short term rates in the economy.

 5) Watch out for any market development steps. In his first interaction with media, Rajan had said that the central bank is considering steps to boost the financial markets in the country. Even if he doesn’t announce concrete steps, he may give away a road map.