RBI cuts CRR by 50 bps; keeps other rates unchanged
Moneylife Digital Team 24 January 2012

The central bank has also revised its growth estimate for the current fiscal at 7% from the earlier figure of 7.6%. It has projected inflation at 7% by the end of March, but added that fiscal slippages are a “significant threat” to the economy

The Reserve Bank of India (RBI) in its quarterly review of the monetary policy, cut the cash reserve ratio (CRR)—the amount of deposits banks keep with the central bank—by 50 basis points (bps) to 5.50% from 6%. The central bank kept other rates like repo and reverse repo rates unchanged due to high core inflation in December.

The cut in CRR will ease liquidity problems faced by banks and is expected to spur growth, the RBI said. The move will lead to an infusion of Rs32,000 crore into the system. With additional liquidity by CRR cut, there is a possibility that banks may reduce the interest rate to attract borrowers.

According to Goldman Sachs, there were strong reasons for enacting the CRR cut. “First, system liquidity is extremely tight. The average daily borrowing at the repo window was Rs1.5 trillion (about $30 billion) in the week of 16th January. This is significantly above the historic borrowing, and the RBI’s preferred system deficit of (+/-) 1% of net demand and time liabilities of banks, which is roughly Rs600 billion (about $12 billion). As a result, the overnight call money rate has shot up significantly above the repo rate and is complicating monetary transmission. Indeed, the liquidity tightness is acting as an increase in the repo rate beyond the 8.50% level the RBI has raised it to. Second, the open market operations done so far have not prevented an inversion of the yield curve, and other liquidity tools are necessary. Third, with the long lags in the system, there is a need to start the easing process early to help investor and corporate confidence to kick-start the recovery in second half of 2012, in our view,” said Tushar Poddar, chief economist, India, Goldman Sachs.

The RBI retained the repo or the short-term lending rate at 8.5% while making it clear that any cut in it will only happen after moderation in inflation. Projecting a lower growth of 7% for 2011-12, the central bank said the policy actions are meant to “mitigate downside risks to growth” and anchor inflationary expectations.

“Based on the current inflation trajectory, including consideration of suppressed inflation, it is premature to begin reducing the policy rate,” RBI governor D Subbarao said while unveiling the third quarterly monetary policy review.

He said, “Even as inflation remains elevated, despite moderation, downside risks to growth have increased. The growth-inflation balance of the monetary policy stance has now shifted to growth”.

He further said slippage on fiscal deficit, crude prices and rupee depreciation are key challenges for inflation, which after remaining near double digit for almost two-years, came down to 7.5% in December 2011.

The chairman of Prime Minister’s Economic Advisory Panel, C Rangarajan, said RBI has taken a “wise decision” and it would lead to softening of interest rate.

“The improvement in liquidity condition will automatically have effect on interest rate. Improvement in liquidity condition will lead to softening of interest rate,” he said.

According to Barclays Capital, the monetary policy is gearing more towards supporting growth despite continued upside inflation risks. "We continue to see risks of a repo rate cut of 25bps in the March mid quarter policy review, while maintaining our base case of start of the rate cut cycle from the April credit policy review. Even with the cut in the CRR, the RBI has flagged that non-food manufacturing inflation remains elevated, and has not seen sufficient softening to justify policy rate reductions as of now," it said in a report.

The RBI has commenced easing cycle with the 50bps cut in CRR. However the monetary policy has put the onus of easing on fiscal and structural policy. Rohini Malkani, economist, Citi India, said, "Given that the growth-inflation balance has shifted to growth, we maintain our view of a minimum 100bps cut in the repo rate in 2012. However, it is worth noting that the RBI has said the timing and quantum would be contingent on policy measures to induce investments and steps towards fiscal consolidation".

The BSE benchmark Sensex rallied by over 186 points in late morning trade soon after RBI announced a cut in cash reserve ratio (CRR) in its monetary policy review.

After rising over 83 points in early trade, the 30-share index rallied further to trade 285 points, or over 1.7% higher, at 17,037.11 at 1323 hrs.

The broad-based National Stock Exchange index Nifty regained 5,100-point level by rising 90 points, or 1.8%, to 5,136.75.

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