The Reserve Bank of India disappointed those who were looking to it, to complete a troika of measures to lift up investor sentiment. Last week, the European Central Bank said it would buy sovereign euro bonds without any limit, and the US Federal Reserve said it would launch a quantitative easing program that would continue for as long as economic conditions remained weak. Then, the Indian government followed up with a series of reforms, including cutting diesel prices and allowing FDI in a few high profile sectors.
The RBI could have been the third force to reviving market sentiment, but it chose to take a more considered view. It has cut the cash reserve ratio by 25 basis points, which will release Rs 17,000 crore to banks which they can use for their fund-based activities. CRR is the amount that banks have to block from their liabilities (deposits), and hand it over to the RBI to be held without paying any interest. Releasing CRR has a multiplier effect, meaning it gets rolled over in the banking system, leading to a higher real impact on liquidity over a longer period.
But the RBI did not cut the benchmark interest rates. In its statement, the Central Bank explained that it had cutinterest rates by 50 basis points in April itself, hopeful of the reforms that are being seen now at that juncture. But they were late in coming. If the CRR was cut, it was to ensure that when credit growth picks up—the season ahead is known as the busy season, when consumer and industrial credit demand normally peaks every fiscal—there is enough liquidity with banks.
One can’t fault the RBI governor’s prudence in holding down interest rates. Inflation continues to be a worry, with wholesale price inflation at 7.6% in August 2012. The government’s fiscal reforms are a source of comfort, but it remains to be seen how much it bends to please its allies. If the RBI had cut rates today, and the government rolled back some of these reforms later this week, the central bank would not be able to roll back its decisions.
The RBI can always step in, even before its next review (which is due on October 30), if the government’s reform measures appear sustainable, gaining credibility.
Impact of the CRR on:
- Banks: they will get more funds to deploy, giving them ammo when credit demand picks up. They can afford to cut deposit rates a little more.
- Individuals: savers will be unhappy, as interest rates on fixed deposits will trend lower. But loans may become cheaper, though with a lag.
- Companies: it will be a little easier to get credit, at stable or even lower interest rates, especially for companies with good credit ratings. If consumer demand picks up, even by a bit, it will be the icing on the cake.