Mumbai, Nov. 1: The Reserve Bank of India (RBI) today sent out a clear rate cut signal to banks and announced measures to shovel another Rs 70,000 crore into a financial system that has been badly strapped for cash.

In a Saturday bonanza aimed at boosting liquidity into the system, stimulating growth and maintaining financial stability, the RBI cut the cash reserve ratio (CRR) by one percentage point to 5.5 per cent, the repo rate by 50 basis points to 7.5 per cent, and the statutory liquidity ratio (SLR) by one per cent to 24 per cent.

The cut in CRR will release Rs 40,000 crore into the system. The CRR is the portion of deposits that banks maintain with the RBI.

On the other hand, the repo is the rate at which banks borrow from the central bank against securities. A reduction in this rate will help banks obtain money at a cheaper rate.

SLR is that amount of bank deposits that must be maintained in the form of government securities. A lower SLR, therefore, means that banks will now have more money to lend as they will not have to buy government securities. The one per cent reduction in SLR is expected to release at least Rs 30,000 crore into the system.

This is the second cut in repo rate by RBI in under a fortnight.

Last month, the central bank lowered the CRR on three occasions. Although the RBI wanted to boost liquidity through these measures, the availability of funds in the system had become tight over the past few days. As a result, the inter-bank call money rates (at which banks borrow money from each other) rose to over 20 per cent on Friday.

The tight liquidity situation has arisen because foreign institutional investors (FIIs) have been taking money out of the country and the central bank has been intervening aggressively to prop up the floundering rupee, which at one stage fell below 50 to the dollar. The dollar sales by the RBI sucked out rupees from the system.

To compound the problem, companies are finding it hard to raise cheap loans abroad and are being forced to seek credit from domestic banks.

The RBI said the CRR reduction would be done in two stages. A 50-basis point cut will take retrospective effect from the fortnight beginning October 25. The reduction of another 50 basis points will come into force from the fortnight beginning November 8.

Reduction logic

Explaining the rationale for the cuts, the RBI said global financial conditions continued to remain uncertain and early signs of a global recession were becoming evident.

It said it was important to ensure that credit requirements for productive purposes were adequately met so as to support the growth momentum of the economy. The global financial turmoil has had “knock-on effects” on domestic financial markets, and this has reinforced the importance of focusing on preserving financial stability.

The RBI also permitted banks to access up to 1 per cent of their deposits from the central bank through a special re-finance window at the repo rate. A back-of-the-envelope calculation shows that this could release another Rs 30,000 crore into the system.

It also extended the SLR relaxation to meet the liquidity requirements of mutual funds and non-banking finance companies. Banks can now maintain an SLR of 22.5 per cent, provided the relaxation is exclusively for the purpose of meeting the funding requirements of non-banking finance companies and mutual funds.

The RBI said it would also buy back the securities earlier sold under the market stabilisation scheme (MSS) as another means of providing liquidity into the system. Details of this scheme will be announced later. At present, banks are holding MSS bonds worth over Rs 1.7 trillion.

Clamour for more

Industry, while welcoming the RBI move, demanded more measures from the government and the central bank to tide over the global financial crisis.

“The RBI could also think of relaxing the restrictions on FII investment in the government debt market to develop a new class of buyers for these securities,” said Chandrajit Banerjee, director-general of the Confederation of Indian Industry.

K.C. Chakrabarty, chairman and MD of Punjab National Bank, said, “We see single-digit deposit rates soon... (we have) already announced to cut peak deposit rate to 10 per cent beginning next month.”

Chakrabarty said a one per cent SLR cut was needed. “This is an extraordinary time, once in a century. The RBI has reduced SLR to infuse liquidity which has to be restored.”

D.S. Rawat, secretary-general of Assocham, said “With this, not only will interest rates subside but enough liquidity will also come into the market to help India Inc expand, diversify and modify its plans.