What does the CRR cut mean for the man on the street?

Moneycontrol Bureau 

The Reserve Bank of India on Tuesday cut cash reserve ratio (CRR) of banks by 50 basis points to 5.50%. The stock market rallied as investors see the CRR cut as a precursor to a reduction in key policy rates-repo and reverse repo-shortly. Many people think a reduction in CRR means that interest rates will automatically come down. But that need not necessarily be the case.

Consider the following:

• CRR is the fixed portion of the net demand and time liabilities (NDTL) that banks mandatorily have to keep with the Reserve Bank of India. Currently, it is at 6%. This means, for every Rs 100 deposits with the RBI, banks will have to set aside Rs 5.50 as CRR instead of Rs 6.  
• Essentially, this will ensure more availability of funds into the system. Banks would have more leeway to extend credit to individuals and companies. According to RBI estimates, the measure is expected to pump in around Rs 32,000 crore into the system.
• A CRR cut does not instantly influence the cost of borrowings while a policy rate-repo or reverse repo--cut will have immediate an impact on interest rates. Repo is the rate at which RBI lends to banks, and reverse repo is the rate at which RBI borrows from the banks. The moment RBI cuts the repo rate, banks will pass on some of the benefit to their customers.
• A CRR cut can indirectly lead to softening of interest rates, as there will be enough liquidity in the system. Also, with demand for credit being muted so far this financial year, banks need to ramp up their lending in the current quarter to meet their full year target. With higher availability of funds, they may offer lower rates to customers to grow their loan book. For the time being, this looks a bit unlikely, given that the cost of funds for banks still remains high.
  

saikat.das@network18online.com