Use incremental CRR to suck out liquidity: Tarapore

With high volatility caused by huge capital inflows becoming a major headache for the Reserve Bank of India, its former deputy governor S S Tarapore has suggested the use of incremental Cash Reserve Ratio (CRR) to suck out the excess liquidity from the banking system.

The RBI has to use all the available instruments such as issuing fresh securities under the market stabilisation scheme (MSS) and hiking the CRR.

To deal with the criticism that the CRR is a blunt instrument, the RBI should consider the use of the incremental CRR, Tarapore said at the launch of Dun & Bradstreet's book "India top banks 2007", on Tuesday.

The incremental CRR prescribes the reserve ratio based on the extent of growth in resources (deposits). It immobilises the excess liquidity from where it is lodged (the banks which show high growth), unlike the average ratio which impounds from the banks which are slow-growing as well as banks which are fast-growing. It also avoids the jerkiness of the average ratio, he said.

The commercial banks are not required to currently maintain incremental CRR. But there is precedence. In the late 90s, a 10 per cent incremental CRR was in vogue on the non-resident deposits to regulate (reduce) the flow of funds from overseas Indians.

Referring to the RBI's action to cool down credit expansion, Tarapore has warned bankers that monetary tightening was far from over and banks should target a 20 per cent credit expansion in 2007-008 to ensure sustainable growth. The Reserve Bank of India's projection was 24-25 per cent.

The RBI may drain out another Rs 60,000 crore in the next six months through a combination of government paper auctions under MSS and hike in the CRR. Thus, the banks would be well advised not to be too euphoric the end of monetary tightening. The capital inflows into the country will continue.