RBI's CRR cut a proactive step, but policy rate cuts still weeks away

RBI's CRR cut a proactive step, but policy rate cuts still weeks away

The central bank took all by surprise when it announced a 75 basis point reduction in cash reserve ratio - a move that will inject liquidity to the tune of Rs 48,000 crore in the banking system.

Rajiv Bhuva
A yawning liquidity deficit in the banking system had led bankers and economists to expect the Reserve Bank of India, or RBI, to deliver a 50 basis point cut in the cash reserve ratio, or CRR, in the mid-quarter monetary policy review scheduled for March 15.

RBI, however, took all by surprise by announcing a 75 basis point reduction in CRR - from 5.5 per cent to 4.75 per cent of banks' net demand and time liabilities - after market hours on March 9.

CRR refers to the percentage of deposits that banks need to park as liquid cash with the central bank.

The latest CRR cut will inject liquidity to the tune of Rs 48,000 crore in the banking system, according to RBI.

FULL COVERAGE: What will Pranab's Budget 2012-13 bring with it?

"Systemic liquidity deficit had worsened substantially in recent months largely due to the RBI's forex intervention (dollar sales) and was expected to worsen further in the second week of March due to advance tax outflows," Sonal Varma, Economist at Nomura India wrote in a research note.

RBI, in its release, said as much, though not in as many words.

"The overall deficit in the system persists above the comfort level of the Reserve Bank. Accordingly, it has been decided to inject permanent primary liquidity into the system by reducing the CRR so as to ensure smooth flow of credit to productive sectors of the economy," the release read.

In order to mitigate tight liquidity conditions, RBI had reduced CRR by 50 basis points in the Third Quarter Review of January 2012, injecting primary liquidity of Rs 31,500 crore into the banking system then.

PERSPECTIVE: Was RBI's 50 bps CRR cut too small?

Simultaneously, the central bank also continued with its open market operations, or OMOs, injecting primary liquidity of over Rs 1,24,500 crore in the current fiscal, of which Rs 52,800 crore was injected after the January policy review.

"Timing of the rate cut is not as much a surprise as the quantum," Varma noted.

The larger-than-expected CRR cut suggests that the RBI has taken care of near-term liquidity concerns and may not need to resort to further open market operations. As a corollary, it is almost sure that the coming policy review is likely to be a non-event.

The CRR cut, in Varma's opinion, does not automatically imply a policy rate cut. "This is because oil prices are already high and the Budget is one day after the RBI's policy review."

Varma expects no further CRR cuts this year and a 100 basis point repo rate cuts in 2012-13, starting in April. The repo rate is the cost at which RBI lends capital to banks.

RBI's easing stance was restricted due to a prolonged period of substantially higher inflation which in turn had affected the non-food credit growth which remained fragile at 15.5 per cent as on February 10, 2012.

However, in the back drop of moderating GDP growth (it was 6.1 per cent in the third quarter of the current financial year), dismal growth in the index of industrial production (1.8 per cent for December 2011) and easing inflation measured by the wholesale price index (Jan 2012 stood at 6.5 per cent), Mumbai brokerage Emkay Global Financial Services had anticipated for a strong case of CRR cut, its Analyst Kashyap Jhaveri noted. "We do not expect banks to immediately reduce their lending rates as they would like to wait for any reduction in policy rates," Jhaveri wrote.

Off late, RBI Governor Duvvuri Subbarao has been vocal about the limitations that monetary policy tools in an economy which runs higher twin deficits on both fiscal and current accounts. So, the tight rope walk of RBI continues.

The Budget, scheduled for March 16, will be something that Subbarao will take his next cues from.