Credit policy: What the RBI is trying to say via CRR cut

Moneycontrol Bureau

In a move that should ease the liquidity crunch in the economy, the Reserve Bank of India (RBI) has cut the cash reserve ratio (CRR) by 50 basis points, underscoring a policy shift from fighting inflation to reviving growth.

The policy rate was cut after signs of sustained moderation in inflation rate emerged, explained Governor Subbarao adding, "CRR cut reinforces guidance to lower policy rates in future."

The policy is almost entirely about liquidity management. The latest cut lowers the CRR to 5.50% from 6.00%, where it had stood since April 2010, and releases Rs 32,000 crore of liquidity into the banking system, the RBI said.

However, quantitative easing of liquidity has its own impact on rates. According to RBI calculations, the primary liquidity Rs 32,000 crore will turn into Rs 1,60,000 crore in due course of time.

Now, the concern is that the expected trajectory of inflation lowering may not happen at all due to this surge in liquidity.

Not exactly, says C Rangarajan, chairman of PMEAC, who feels, the CRR cut is a " wise decision " by the central bank. "It will add to the total liquidity in the system but it need not necessarily come in the way of inflation easing. I believe that the food inflation will continue to fall till March," he told CNBC-TV18.

Suman Bery, country director of IGC feels the RBI has got the balance right this time around. He said it is not a given that this increase in high-powered money will result in secondary monetary creation.

The RBI's move is also seen as the Governor's message to the government to do more in the coming months.

"It must be emphasised that the timing and magnitude of future rate actions is contingent on a number of factors. Policy and administrative actions, which induce investment that will help alleviate supply constraints in food and infrastructure, are critical," Subbarao said.

Which basically means: the ball is firmly in the government's court and it needs to cut down on its spending for better inflation management and any meaningful chances of rate cuts in future.

"In the absence of credible fiscal consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending." Subbarao said 

"The forthcoming Union Budget must exploit the opportunity to begin this process in a credible and sustainable way," the governor stressed. 

That's the domestic message. The international message is that RBI is not about to have a party at a time when the rupee has been depreciating and global conditions are as fragile as they are.

So what happens next? Well, the jury is still out on a repo rate cut given the uncertain environment we live in. The half percentage CRR will most likely be followed by continued open market operations (OMO).

"My personal expectation is that there will be further Rs 50,000 crore of OMOs. We could be in the range of 8-8.10% in terms of yields," Anant Narayan of StanChart said.

Sagar Salvi
sagar.salvi@network18online.com