RBI likely to cut CRR further, say economists

Economists are now predicting that the Reserve Bank of India (RBI) would resort to another round of cut in the Cash Reserve Ratio (CRR) in order to inject extra liquidity into the money market.

In the wake of the ongoing global financial crisis, lending between banks has become costlier because of demand exceeding the supply in the money market.

“The RBI’s decision to cut CRR is a right move. But it does not signal that interest rates are coming down”, said Dharmakirti Joshi, economist with CRISIL Ltd, a ratings and advisory firm. “Another round of cut in CRR is expected”, he added

CRR is the percentage of bank deposits that are parked with the Reserve Bank of India (RBI) and is used as a monetary tool to manage the availability of cash in the system. RBI, on Monday, cut the CRR rate by 50 basis points, a move that is expected to bring an additional Rs 20,000 crore into the system.

Shankar Acharya, honorary professor with the Indian Council for Research on International Economic Relations (ICRIER), said it was only natural that CRR would be cut when capital is flowing out of the country.

RBI resorted to higher CRR as a way of ‘sterilising’ (referring to taking excess liquidity) unprecedented capital inflow in the last three years up to March 2008, he said. Foreign investors have so far taken out in excess of $ 9 billion from the Indian equity market and this has put pressure on Indian rupee which crossed the Rs 48 mark to a dollar on Tuesday.

Joshi said RBI defending the Indian rupee against the US dollar is also affecting the liquidity in the market. To prop up the rupee, RBI is buying rupees and selling dollars in the currency market. Globally, the lack of trust in the wake of sub-prime crisis in US has affected lending in the credit market. This has sharply increased the short term borrowing rates for banks and also for companies. Led by US central bank, Federal Reserve, several central banks are addressing this problem by providing additional liquidity to the credit market.

“Now that the holy coconut of the CRR has been broken, further cuts cannot be ruled out. CRR changes are never announced in scheduled policy meetings as they are a response to the evolving liquidity scenario”, Rajeev Malik of Macquarie Research said in a note released on Tuesday

“The policy meeting (of RBI) on October 24 is now largely academic, unless the global backdrop and dollar supply into India worsen significantly. The hey takeaway from the policy statement will likely to be the RBI’s expectation of the inflation trajectory, and its guidance- if any- about the timing of the monetary easing given downward risks to growth”, Malik added.

Going forward, Acharya said it would be a wrong policy on the part of RBI to defend the exchange rate in the background of foreign institutional investors taking money from India.

Malik said, “We continue to expect nearly 200 basis point cuts in the repo rate (the rate at which the RBI injects liquidity) and the CRR from early next year”.