Reserve Bank of India Cuts Cash Reserve Ratio by 75 bps to Ease Liquidity

The Reserve Bank of India (RBI) made the decision on Friday to cut its cash reserve ratio (CRR) by 75 basis points in a response to continued shortage of liquidity in the banking sector.

According to Capital Economics, a macroeconomics research consultancy, this does not imply that the bank is preparing to cut the policy interest rate (the repo rate) at its regular rate-setting meeting next Thursday. But it does signify that the RBI is keen to ease constraints on lending and we do anticipate that the bank will cut the repo rate from 8.5 to 7.0 percent by the end of this year.

This move cuts the CRR from 5.5 to 4.75 percent, which will be effective from March 10. Capital Economics points out that the surprise is the timing of the cut, which is just six days before the RBI’s mid-quarter review meeting next Thursday. The RBI’s statement explains that it is intended to head off an escalation of the liquidity shortage in the banking sector in the second week of March due to year-end tax payments.

At the same time Andrew Kenningham, Senior Global Economist of Capital Economics, stated that this decision does not change the view about the timing of cuts to the repo rate, which is the more powerful monetary policy instrument.

Capital Economics is of the opinion that the RBI will leave its repo rate unchanged at 8.5 percent at its policy-setting meeting next Thursday as it will want to see a longer period of falling inflation and be reassured that the budget for 2012 sets the central government’s finances back on course before cutting rates.

At the same time it also mentioned that next week will see the release of inflation and industrial production data, as well as presentation of next year’s budget, all of which may prepare grounds for the RBI to cut the repo rate in April.