Dr. Raghuram Rajan has raised the repo rate (overnight borrowing rate for banks) by 25 basis points (0.25%) to 7.5%.
Banks which were required to keep 99% of the Cash Reserve Ratio (CRR) at all times, are now required to keep a minimum of 95% which gives them some breathing room. (Average over the fortnight must be 100%). Currently banks are keeping around 3.18 trillion, about 5% more than the required 3.01 trillion, to avoid going under. This gives them room to reduce that by about 10,000 cr. (100 billion), which is effectively a saving of around 1,000 cr. a year (considering a 10% cost) for the banking system or Rs. 250 cr. a quarter.
CRR freedom helps banks keep less money interest-free at the RBI and they can invest it elsewhere.
He has also tried to unwind part of “Operation Knicker-Twist” (not their name) by the last governor, D. Subbarao.
The Marginal Standing Facility which was at 10.25% is now down to 9.5%. This means the “corridor” for borrowing more than 0.5% of NDTL (sum of all deposits, to simplify) is now 200 basis points (2%) above the repo rate.
Effective overnight rates are now 9.5% because repo is limited. There is no increase in the limit that banks can borrow under repo. (which is 0.5% of NDTL, currently that translates to 40,000 cr.)
That means short term rates come down 0.75% (from 10.25% to 9.5%) and longer term rates, pegged to the “intent” behind the repo, will go up. The yield curve that is currently ‘inverted’, will become more normal. I’ll call this “The Rajan Untwist”.
I’m now going to take some credit for a prediction (which I didn’t want to do) in my earlier post on “What Will Rajan Do Today?”. I had said:
- Rajan should raise rates to control inflation. (But I doubt he will)
- The liquidity tightening must continue to support the anti inflationary cause. But since they pitched it as a dollar-rupee control measure, it is unlikely to. So CRR might be eased (in terms of % maintained).
- The MSF window might come down – Again, my view is to keep those rates high no matter what. From 10.25% we might see a 10% rate though.
- I believe he must act on some of the other things he mentioned, like a freer rupee.
- Also, on the “default” front, I hope Rajan introduces strict measures for banks to recognize and not evergreen defaulting loans. Very tough restructuring norms and penalties will help.
The last two aren’t addressed. The rest seem to be inline.
Remember this: The signal we are getting is that inflation is more important than growth right now. Which means that until CPI inflation shows considerable easing, we are likely to see more policy rate increases. This means credit growth will be curtailed, and that is bad for overall economic growth – this is a short-term negative for markets.