RBI may cut CRR next month over tight liquidity concerns

Market participants expect that persistently tight liquidity conditions may lead to another round of cut in banks’ cash reserve ratio (CRR), as the Reserve Bank of India (RBI) announces its mid-quarter policy review on March 15.

Despite infusion of Rs 32,000 crore in January through a cut of 50 basis points in CRR, liquidity has continued to stay way above the comfort zone of the central bank. RBI said in the third-quarter policy review that it preferred liquidity deficit of up to one per cent of banks’ net demand and time liabilities (NDTL) that worked out to around Rs 60,000 crore.

However, lenders have been consistently borrowing above Rs 1 lakh crore on a daily basis, since the relaxation in CRR. Today, banks borrowed Rs 1.66 lakh crore from RBI under the Liquidity Adjustment Facility, at a repo rate of 8.5 per cent.

Pressure on system liquidity is expected to worsen on account of last instalment of tax payments in March. Economists at Barclays Capital expect the liquidity deficit to move towards Rs 1.7 lakh crore by end-April. “Even if the RBI cuts CRR by 50 basis points at each of the next two meetings (March and April), it will still need to inject a further Rs 35,000 crore of liquidity via other means, most probably via open market purchases of bonds,” said economists Siddhartha Sanyal and Kumar Rachapudi, Barclays Capital.

Sajjid Chinoy, India economist at JP Morgan expects cut of 50 basis points in CRR in March. “According to our estimates, it will help in bringing down the liquidity deficit to about Rs 1.1 lakh crore which would still be higher than the RBI's comfort zone,” he said. This assumes that the central bank will not intervene in the foreign exchange market to support rupee and the pace of Open Market Operations (OMOs) will continue, he added.

According to data from RBI, there was liquidity infusion of about Rs 71,000 crore via bond purchase under OMO auctions since November. The auctions were aimed at supporting markets so that the heavy borrowing plan of the government passes smoothly. Government has been raising Rs 13,000-14,000 crore whereas RBI has been infusing Rs 8,000-10,000 crore via OMOs every week.

Yields on the 10-year benchmark government bonds had shot up to three-year high levels of nine per cent when upward revision of the government borrowing plan was announced. However, OMOs conducted by RBI helped in cooling the yields. Moses Harding, head of research at IndusInd Bank, said, it is important for RBI to deliver a 50 bps rate cut along with a 50 bps CRR cut to arrest overshoot in the 10-year bond yield above 8.30 per cent into 8.40-8.50 per cent.

In terms of foreign exchange intervention, RBI sold $7.8 billion in December, $2.9 billion in November and $943 billion in October 2011. The central bank also intervened in the forwards market to the tune of $1.3 billion in December and $1.6 billion in November 2011. “RBI’s intervention in the forwards market is affecting rupee liquidity as the contracts must be maturing now,” said the official.

Also, year-end pressure on banks to meet business targets will weigh on the system liquidity.