The 25 basis points cut in CRR would infuse Rs17,500 crore in the financial system, thus allowing banks to reduce interest rates on loans to attract borrowers
The Reserve Bank of India (RBI), in its second quarter monetary policy review, has the cut cash reserve ratio CRR—the amount of deposits banks keep with the central bank—by 25 basis points (bps) or 0.25% to 4.25%. The central bank, however, kept other policy rates like repo rate, reverse repo rate and bank rate unchanged at 8%, 7% and 9%, respectively. The central bank, however, indicated ‘reasonable’ cut in policy rates soon.
The cut in CRR is expected to release Rs17,500 crore into financial system. With additional liquidity by the CRR cut, there is a possibility that banks may reduce the interest rate to attract borrowers.
In a statement, D Subbarao, governor, RBI, said, “In reducing CRR, the Reserve Bank intended to pre-empt a prospective tightening of liquidity conditions, thereby keeping liquidity comfortable and supportive of growth. The policy stance anticipates the projected inflation trajectory which indicates a rise in inflation over the next few months before easing in the last quarter. While there are risks to this trajectory, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of this fiscal year.”
According to Sonal Varma and Aman Mohunta from Nomura, the CRR cut and guidance given by the RBI are in their line of view that headline and core inflation will likely ease from Q1 2013 onwards, thus creating space for the RBI to cut the repo rate. "Given political pressure on the RBI to cut rates at this meeting, we see today's decision as prudent and fortifying the RBI's inflation fighting credibility," the Nomura economists said.
Siddhartha Sanyal and Rahul Bajoria from Barclays said, "We maintain our view of further rate cuts in Q1 2013 and continue to forecast a 100bp reduction in the repo rate during H1 13. While holding back from making rate cuts, we think the Indian central bank recognises the need to support faltering growth, and expect it to continue to provide liquidity to meet its money and credit growth targets."
India’s headline wholesale price index (WPI) inflation moderated from its peak of 10.9% in April 2010 to an average rate of 7.5% over the period January-August 2012. During this time, growth has slowed and is currently below trend. This slowdown is due to a host of factors, including monetary tightening.
“It (inflation) turned up again in September, reflecting the partial pass-through of adjustment of diesel and electricity prices, and elevated inflation in non-food manufactured products. It is, therefore, critical that even as the monetary policy stance shifts further towards addressing growth risks, the objective of containing inflation and anchoring inflation expectations is not de-emphasised,” the RBI governor said.
"FICCI believes that while a reduction in interest rate is imperative to revive investment growth, there would be some leeway now for banks to lend more to the productive sector via the CRR cut," said RV Kanoria, President of FICCI.
RBI said the loss of growth momentum that started in 2011-12 has extended into 2012-13 though the pace of deceleration moderated in the first quarter. Nevertheless, growth remains below trend and persisting weakness in investment activity has clouded the outlook. After decelerating over four successive quarters from 9.2% year-on-year (y-o-y) during fourth quarter of FY11 to 5.3% in same period of FY12, GDP growth was marginally higher at 5.5% in Q1 of FY13. The slight improvement in GDP growth in Q1 of FY13 was mainly driven by growth in construction, and supported by better than expected growth in agriculture.
"While liquidity has been accorded top priority, relatively smaller magnitude of CRR cut, no announcement of open market operations (OMOs) and scaling down of monetary projections by 1% point to continued tight liquidity condition going forward. If however, RBI conducts ad hoc OMOs to ease liquidity then it can still infuse a downward bias to interest rates that would help the market and the economy," said Motilal Oswal, CMD, Motilal Oswal Financial Services Ltd.
Meanwhile, stock markets, which were expecting more cuts in policy rates from the RBI, fell by over 1% after the policy announcement. At 11.50am, the BSE Sensex was trading 1.1% down at 18,436, while the NSE Nifty was down by 1.2% at 5,598.
Sandesh Kirkire, CEO Kotak Mutual Fund, said, "This deferment of the repo rate cut has disappointed the market to certain extent. With growth rate regressing; and with most of the inflation factors like oil prices and food supply largely unresponsive to the monetary policy influence; it is only a matter of time that we would see the repo rate easing over the next few quarters."
"We think a further cut in the CRR is possible if the liquidity situation warrants, but the RBI will likely use this tool less aggressively, given that the rate has already been reduced by 175bp in 2012 and is at an historical low. Open market operations (OMOs), which have been used to inject over INR800bn of liquidity during FY 12-13, will likely remain a key tool to inject liquidity in the coming months, in our view," Sanyal and Bajoria from Barclays added.