RBI Shifts Focus to Growth, Cuts Cash Reserve Ratio by 50 bps

Andrew L D'Cunha

Mangalore, Jan 24: India’s central bank cut its cash reserve ratio (CRR), by 50 basis points to 5.5% today bring cheer to financial circles. One basis point is one hundredth of a percentage point. The market had expected that key rates would remain unchanged. RBI’s measure will lead to an injection of Rs 32,000 crore into the financial system. The CRR cut is effective from the fortnight beginning January 28, 2012.

Cash Reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the economy from time to time. If RBI decides to increase the percent of this, the available amount with the banks comes down., The lower this ratio, the higher is the amount that banks can lend out. If the percentage of CRR is increased, banks will be parking more money to RBI and it leads to less liquidity with the banks, results in tightening the monetary policy. CRR is a major qualitative monetary tool with which the RBI plays upon to control the situation in the economy.

Since last two years RBI was focusing on controlling the inflation. RBI in its mid quarter policy review had kept the key rates unchanged. Now, by reducing CRR, RBI has shifted its focus towards Growth. In October, the RBI, for 13th time since March 2010, increased repo (the rate at which the RBI lends money to banks) and reverse repo (the rate at which the RBI borrows from banks) rates by 25 basis points (bps) each to 8.5% and 7.5%, respectively to control inflation. The series of rate hikes has cumulatively increased interest rates by 525 bps in the last 22 months.

In reducing the CRR, RBI has attempted to address the structural pressures on liquidity in a way that is not inconsistent with the prevailing monetary stance. In the two previous guidance, it was indicated that the cycle of rate increases had peaked and further actions were likely to reverse the cycle," the RBI said in its third quarter review of annual monetary policy for 2011-12.
 
"The persistence of tight liquidity conditions could disrupt credit flow and further exacerbate growth risks. In this context, the CRR is the most effective instrument for permanent liquidity injections over a sustained period of time. The reduction can also be viewed as a reinforcement of the guidance that future rate actions will be towards lowering them," it added.
 
The central bank lowered its credit growth expectation to 16% for 2011-12 from 18% earlier.
 
RBI also reduced its gross domestic product growth (GDP) forecast for the current financial year to 7% from 7.6% earlier but retained its inflation outlook at 7% by March-end.

The stock market reacted positively to the policy announcement and the banking stocks, in particular, shot up. The Sensex jumped 244 points to close at 16996.. The 30-share index touched a high of 17050 in trade today. Nifty touched the 5,100 level for the first time since November 15, 2011. it touched a high of 5141 and closed at 5127 points. Banks and capital goods are gained almost 3.5% each.

Andrew L D'Cunha, managing director, WinWin Fin Advisory Pvt Ltd Mangalore. Email: finadvisoryltd@yahoo.com.