A look into recent RBI decisions

The Reserve Bank of India’s third quarter recapitulation of monetary policy was devoid of major surprises. The only change in monetary policy instruments was a cut in the Cash Reserve Ratio (CRR) by 0.50% point to 5.5%.

This decision will in turn resulted in-

  • Release of Rs.32,000 Crore of funds squeezed from banks.
  • The key policy interest rate, the repo rate, remains unchanged at 8.5%.
  • The reverse repo stays at 7.5 per cent and the marginal standing facility at 9.5%.

A cut in the repo rate would have more emphatically indicated a downward shift in the monetary position but the RBI has reasoned that the CRR reduction is the best it could do under the prevalent circumstances and are thus interpreted as a signal for a softer monetary policy regime.

As per RBI, the CRR is a policy tool with fluidity dimension. Its reduction will bring down the cost of money for banks and their ability to lend at lower rates.

Reason quoted by RBI

The RBI has quoted 3 well known reasons in support of its latest stance. Economic growth is decelerating due to the cumulative effect of past monetary tightening and domestic policy uncertainty, combined impact of uncertain global environment.

1. The growth in demand was slowed down as a result of earlier monetary policy moves to control inflation, at this critical point risks to growth have increased.

2. The fall in WPI inflation is due to a sharp down fall in the prices of seasonal vegetables. However, protein-based food items and non-manufactured food inflation remain high.. Global petroleum prices remain high. The lingering effect of recent rupee depreciation continues and there is a significant slippage in the fiscal deficit.

3. Liquidity conditions have remained tight beyond the comfort zone of the RBI despite massive infusions through open market operations.

All these have postponed RBI’s decision to cut the repo rate.

‘A forcing out’ consequence

For an instance Money supply has been on expected lines but non-food credit growth at 15.7 per cent has been below the indicative projection of 18 per cent. The latter is due to the combined impact of a slowing economy and risk aversion among banks concerned over non-performing assets (NPAs). There is also ‘a crowding out’ effect of increased government borrowing. Net credit to government has increased at a significantly higher rate of 24.4 % as compared with 17.3 % last year. But the RBI has done its bit to ease liquidity by buying back dated securities, for instance. Far more difficult it is to reconcile low credit off take with liquidity shortage.

The only explanation is that banks have become even more timid of lending than is apparent. As pointed out earlier, an increase in the NPAs does contribute to increased risk aversion among banks.

Troubles for the Power Sector

A number of infrastructure sectors, especially power have bogged down in deep financial troubles.

Telecom is in a mess. More recently, Air India and Kingfisher Airlines have shown how the financial trouble affected civil aviation.

Averting to lending

With the dominance of government banks, it is of extreme importance to put in place a system of accountability, which will not sanction risk-taking.

In brief, the RBI’s on a CRR cut as a means of assuaging the disappointment over the absence of more overt repo rate reduction might have paid off in the short run. Stock markets are up. But for the CRR cut draws attention to some structural blocks such as risk aversion that will limit its potential.