India’s RBI Cuts Cash Reserve Requirement

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Jan. 30 – The Reserve Bank of India cut cash reserve requirements (CRR) for banks by 50 basis points last Tuesday to relieve tight liquidity, indicating a policy shift towards reviving growth after nearly two years of fighting inflation. With core inflation still inflexibly high, the RBI left its policy repo rate unchanged at 8.50 percent for the second consecutive review. The central bank had raised rates 13 times between March 2010 and October 2011, which made it one of the most hawkish central banks over that time period.

Bond and exchange markets at first commended the CRR cut before being disappointed in that there was no perfect guidance on a policy rate cut – pushing bond yields and swap rates higher. The BSE Sensex, though, was sharply higher, rising as much as 1.66 percent on the day powered by bank shares.

Expectations had grown in recent days that the RBI would cut the CRR and the cut on Tuesday lowered the CRR to 5.50 percent and released Rs. 320 billion of liquidity into the banking system.

Inflation worries persist
The RBI kept to its hawkish position long after most central banks shifted their focus to growth, as inflation in India remained high due to elevated food prices, infrastructure bottlenecks, and an expansionary fiscal policy that pushed up rural spending power and strained government finances.

Yearly inflation, measured by the wholesale price index, slowed to a two-year low of 7.47 percent in December, because of a decline in food inflation. However, manufactured product inflation edged up from the previous month.

The 16 percent drop in the rupee in 2011 has made imports even more expensive.

As estimated, the RBI lowered its GDP growth forecast for the fiscal year that ends in March to 7 percent from 7.6 percent, and left its wholesale price index inflation target unchanged at 7 percent for the end of the fiscal year in March. Asia’s third-largest economy grew 8.5 percent in the previous fiscal.

CRR signal
Indian banks borrowed Rs. 1.42 trillion from the RBI’s repo window, more than double the Rs. 600 billion that would indicate a liquidity deficit of 1 percent. The RBI’s guideline is for liquidity deficit or surplus within 1 percent of aggregate deposits.

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