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Reserve Bank's latest move to soak up the entire surplus liquidity between September 16 and November 11 through incremental cash reserve ratio (CRR) will lead to over Rs 3 trillion outflow from banks and is likely to impact interest rate transmission, cautions a report. Over the weekend, RBI had asked banks to set aside 100 per cent of the deposits between September 16 (weeks before the end of the income disclosure scheme) and November 11 (three days after the currency delegalisation was announced) as incremental cash reserve ratio balance with it. RBI, however, said it was a "purely temporary measure". "The higher CRR is applicable on incremental deposits, which would mean deposits of nearly Rs 3 trillion that accrued to banks between September 16 and November 11 will be impounded by RBI," Crisil said in a note here today. The immediate impact of this step is seen to cause liquidity to tighten and send bond yields higher with ripple effect on interest rate transmission. "Banks could delay cutting their lending rates, given that they have promised at least 3-4 per cent interest rate to savings account depositors, but will be not be receiving any interest on the deposits impounded for CRR," Crisil noted. Meanwhile, Wall Street brokerage Citi in a report said the CRR move would have been driven by three factors. First, the surplus in the banking system at Rs 5 trillion was inching closer to the maximum absorption capacity of RBI.
The central bank had Rs 7.5 trillion of G-Secs prior to the demonetisation drive that acts as collateral to absorb banking system surplus through the reverse repo window.
"RBI's estimate of deposit accretion going forward might have prompted them to announce a large CRR hike which would obviate any discussion around RBI running short of G-Secs," Citi said in a report.
Second, the report said, the process of putting in place other liquidity absorption measures like issuance of market stabilisation scheme (MSS) bonds was taking time, as mentioned by RBI Governor Urjit Patel.
Issuance limit of MSS bonds for this year was set at Rs 30,000 crore earlier which Citi felt was too small given the liquidity absorption requirement.
It said the strong action could also be aimed at signalling RBI's reluctance on market interest rates falling too sharply, too soon in the present global context.
"The surplus rupee liquidity and sharply falling rates were also creating distortions in the forward premia and indirectly impacting the spot dollar-rupee rates," the report said, adding that the measure could reverse some of these distortions.
Crisil further said RBI's prognosis on growth downside due to the demonetisation will be a key factor in deciding repo rate at December 7 policy review meeting.
Crisil further said the RBI's prognosis on downside to the growth due to the demonetisation will be the key factor driving the repo rate decision on December 7 monetary policy review meeting. Since the last monetary policy review, the downside risks to growth have risen and that to inflation have subsided. "The fall in the value of rupee could exert some upward pressure on the imported component of inflation. We believe the odds are in favour of a 25 bps repo rate cut to 6 per cent," the Crisil report said. According to Citi, the risks of a sharp near-term growth decline may warrant a 25 basis points rate cut on December 7 to arrest any spillover effects of the negative shock arising from the demonetisation drive. "Yet we acknowledge some possibility that RBI stays put in December to better assess the impact on economic activity/liquidity and keep the options open for even an inter-meeting rate cut," Citi said.