CRR cut: Durable liquidity to shield FII uncertainties, say experts

Reserve Bank of India

A cut in the cash reserve ratio (CRR) is expected to add durable liquidity in the banking system when there are outflows lined up because of goods and service tax and advance payments this month, experts said.

In addition, the durable liquidity in the banking system will provide a shield from the outflows of foreign investors in equity market, experts said. This is because, whenever there is an outflows, it puts pressure on the Indian rupee, which prompts central bank to intervene in the forex market to curb volatility, which ultimately have an impact on banking system liquidity.

When the central bank sells dollars, it sucks out an equivalent amount in rupees, thus reducing the rupee liquidity in the system.

The reduction of CRR by the Reserve Bank of India (RBI) in the December policy will infuse Rs 1.16 lakh crore liquidity in the banking system. It will be done in two tranches, of 25 bps each with effect from the fortnight beginning December 14, 2024 and December 28, 2024.

CRR is a percentage of a bank's deposits that must be kept with the central bank as a reserve. The RBI uses this tool to control inflation, money supply, and maintain liquidity in the economy.

RBI Governor Shaktikanta Das, during post policy press conference, also said the central bank expects tight liquidity in the remainder of the financial year.

The banking system is expected to witness outflows of over Rs 3 lakh crore from the banking system on back of tax payments.

The RBI intervention in the spot and forward market is evident from the data to protect rupee from falling sharply. The RBI has been using NDF market interventions for the past seven months as part of its campaign to limit volatility in the rupee's value.

According to RBI bulletin data, outstanding net forward sales by the central bank stood at $14.580 billion in September, $18.98 billion in August, $9.10 billion in July, $15.83 billion in June, $10.36 billion in May, $16.257 billion in April and $541 million in March.

During 2024-25 (April-November), the Indian rupee (INR) depreciated by 1.3 per cent largely due to pressure from strengthening US Dollar and selling pressure by foreign portfolio investors in October and November, RBI said in a release.

Further, even the outflows from foreign investors in equities have stabilized, but the pressure on rupee is still there, which may force central bank to intervene in the market. Today, Indian rupee ended at 84.69 against the US dollar. It is down 4 paise from its all time low.

Apart from this, some experts believe that the durable liquidity will also enabling banks to enhance lending to various sectors and improve net interest income.

“Its decision to reduce CRR to 4 percent will act as catalyst in release of Rs 1.16 lakh crore into the economy, improving liquidity and enabling banks to enhance lending to various sectors,” Ajay Kumar Srivastava, Managing Director and CEO, Indian Overseas Bank.

Further, Radhika Rao, Executive Director and Senior Economist, DBS Bank said industry observers opined that the CRR cut could translate to a 2-6 basis points improvement in domestic banks’ net interest income (assuming all funds are deployed for loans).

Today, the central bank kept the key policy rates unchanged at 6.5 percent as inflation stayed above the central bank’s comfort zone and a slowdown in economic growth forced it to revise its forecast downward.