CRR reversal 'welcome step' for liquidity: Ashvin Parekh

Ashvin Parekh

The monetary policy committee (MPC) has decided to have a status quo on the policy rates for this bi-monthly monetary policy. However, the incremental CRR requirements have been withdrawn from 10th December onwards. Major factor contributing to the stable monetary policy rate could be impending concerns about inflation and, perhaps in the backdrop increase in the US Fed rates. On MPC’s view on growth for the economy, there is a downward revision by about 50 bps. The growth for the year is now expected to be 7.1%. The impact of 7th Central Pay commission, as commented by the Governor has not yet impacted the economy and the consumption growth arising out of the full pay out will be felt in the next 2 quarters promoting inflation tendency. Also, there is recognition of oil-price hardening.    

The withdrawal of specified bank notes has unfolding effects. The MPC itself feels that these effects have clouded the assessment. There has been a steady expansion of the agricultural land due to the robust agricultural performance due to good monsoon. There was some pick up in the industrial activity before the demonetization took place. Demonetization may disrupt some part of industrial activity in the ongoing months. GVA by financial services is expected to receive a short-term boost from the large inflow of low-cost deposits.

Liquidity conditions have changed drastically in quarter 3. Surplus conditions in October and early November were engulfed by the impact of the withdrawal of SBNs after November 8th. RBI scaled up its liquidity operations through variable rate reverse repo auctions of a wide range of tenors from overnight to 91 days, absorbing liquidity (net) of 5.2 trillion.

The policy on CRR will once again ensure higher liquidity in the system and support consumption. This may be one of the reasons why the growth estimates have been revised only by 50 bps. Also, the banking system will benefit due to enhanced spread in the interest received and paid. The economy could expect the transmission of the rate cuts made earlier since 2015 of 175 bps from the banking system to flow into the economy. Both from the liquidity management and currency price stability, these measures are very welcome.

The surprise in the press discussions that would draw the nation’s attention is the fact that INR 11.5 lakh crores worth of notes have either been exchanged/deposited. We still have 3 weeks to go before the window of currency deposit is withdrawn. Out of the total of INR 14.14 lakh crores of notes (in 500 and 1000 denomination) if almost the entire amount officially circulating in the economy is deposited then, it could pose several new challenges to both the government and the regulator. By way of substantial consolation, the audit trail of deposits and digital records will now be available with the system to investigate the matter.

Overall therefore, MPC should be commended for taking a wait and watch policy. However, more detail on demonetization and its impact would have been very welcome.