Though Economic Survey 2014-15 highlights the need to reduce the required statutory liquidity ratio (SLR) for banks to free resources and meet credit demand, much of it will depend on the government’s fiscal discipline.
SLR is the proportion of net demand and time liabilities (NDTL) a bank needs to invest in government paper. A reduction in this ratio is fruitful if accompanied by a fall in the government’s market borrowings, as banks are the key buyers of bonds.
It is expected in Budget 2015-16, to be presented on Saturday, the government will adhere to a fiscal deficit target. The target for 2014-15 is 4.1 per cent of gross domestic product (GDP), while for 2015-16, the government plans to restrict its fiscal deficit to 3.6 per cent of GDP.
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“As the banking sector exits financial repression on the liability side, aided by a fall in inflation, this is a good opportunity to consider relaxing asset side repression. Easing SLR requirements will provide liquidity to banks and depth to the government bond market, and encourage the development of the corporate bond market,” said Economic Survey 2014-15.
“A reduction in pre-emptive funds, particularly in the wake of adherence to fiscal consolidation, as indicated by the government, gives RBI (Reserve Bank of India) the scope of easing some of the funds. This paves the way to improved credit flow to the private sector, given the growth impulses that are likely to play out through the next few months. So, an SLR cut could be a precursor to fiscal consolidation,” said Shubhada Rao, senior president and chief economist, YES Bank.
In the sixth bimonthly monetary policy review early this month, RBI had cut the SLR by 50 basis points to 21.5 per cent of banks’ NDTL. As a result, banks could have an additional Rs 40,000 crore available for deployment. Experts say more rate cuts are likely in the coming monetary policy reviews.
S K Ghosh, chief economic advisor, State Bank of India, said the suggestion to cut the SLR should be seen as signal for fiscal consolidation. The reduction will release resources to meet demand for credit when investments and economic growth picks up. But as of now, with tepid demand for loans, the banking system’s SLR holdings are five per cent above the floor rate of 21.5 per cent.
Akin to the central government, state governments also approach the market to finance their deficits; securities issued by state governments have SLR status in India.
There is no minimum stipulation on SLR. Earlier, SLR of at least 25 per cent was mandated but this was removed through an amendment to the Banking Regulation Act in 2007. RBI can raise the required SLR up to 40 per cent, based on its assessment of liquidity in the system.