Mumbai, Oct. 6: The Reserve Bank of India today surprised the financial markets by slashing the cash reserve ratio (CRR) by half a percentage point to 8.5 per cent.
The CRR is that portion of deposits that all banks must maintain with the central bank.
The apex bank has been tightening monetary controls over the past three years to control inflation.
Todays CRR cut will pump another Rs 20,000 crore into the system. However, bankers felt the move would not lead to a cut in interest rates.
The CRR cut was undertaken to improve cash flows in the banking system. The market has turned tight for a variety of reasons.
Foreign investors have been selling stocks on the local bourses, converting the proceeds into dollars and carting it out of the country.
The draw down of dollars has started to put pressure on the rupee which has depreciated by almost 18 per cent this year.
However, aggressive dollar sales have led to the mop-up of the rupee, creating a cash shortage in the system.
Last months advance tax payments exacerbated the cash crunch. This resulted in call money rates (rate at which banks borrow from each other) touching nearly 13 per cent.
This is the second major liquidity support move of the RBI in recent times. Last month, the central bank effectively created a corpus of Rs 30,000 crore that banks could tap to meet their cash needs.
At that time, it had permitted banks to draw additional funds under the liquidity adjustment facility. This is an instrument through which the central bank determines how much cash swirls around the system.
Worldwide, central banks have been taking steps to infuse liquidity into the banking system to prevent a credit crunch.
Central banks across the world have stepped up their liquidity operations, including coordinated actions, and some have banned or limited short selling of financial stocks, the RBI said in a statement today.
However, the central bank cautioned that the CRR cut is temporary in nature and will be reviewed on a continuous basis in the light of the evolving liquidity conditions.
This is a clear hint that the reduction in CRR should not be construed as a sign that the central bank is going back to the rate reduction days.