Mumbai, Sept. 17: Policymakers at the Reserve Bank of India today decided to leave the policy rate — the repo — unchanged at 8 per cent, but slashed the cash reserve ratio (CRR) by 25 basis points to 4.50 per cent, pumping another Rs 17,000 crore into the financial system.
CRR is that portion of their deposits that banks must park with the RBI. The ostensible reason for the move was that the RBI wanted to avoid a tight liquidity situation during the festival season. The repo rate is the rate at which the RBI provides liquidity to banks against collateral.
The spotlight had turned on the RBI’s mid-quarter monetary policy review after the Centre bit the bullet last week by raising diesel prices across the country by an unprecedented Rs 5 a litre and slashing the number of subsidised LPG cylinders per family to six a year.
The government had also given a strong push to the reform process by permitting foreign airlines to invest in Indian carriers and foreign investors to hold up to 51 per cent in multi-brand retailing operations.
All along the RBI has been saying that the government’s inability to take a stab at fiscal consolidation had undermined the effectiveness of its monetary policy changes. The RBI has often said in the past that the reduction of the policy rate is contingent upon lower inflation and fiscal consolidation by the government.
Last Thursday, the government had tossed the ball into RBI’s court with its tough measures to set its fiscal house in order.
The aggressive steps taken by the Centre to put the country on the road to fiscal consolidation had raised the hope in some quarters that the central bank would also reciprocate by lowering the repo rate.
The RBI said it had decided to leave the repo rate unchanged as the threat of inflation had not receded even as it complimented the Centre for the steps it announced last week.
Headline inflation in August had come in higher than expected at 7.55 per cent. Further, core inflation, or non-food manufactured products inflation, was also higher at 5.6 per cent in the same month.
“While the recent upward revision in diesel prices and rationalisation of subsidy for LPG is a significant achievement, in the short-term, there will be pressures on headline inflation. Over the medium-term, however, it will strengthen macroeconomic fundamentals,” it said in the monetary policy document.
The RBI went on to add that as inflationary tendencies have persisted, the primary focus of monetary policy remains the containment of inflation and the anchoring of inflation expectations.
The apex bank said the government’s recent actions had paved the way for a more favourable growth-inflation dynamics as it would initiate a shift in expenditure away from consumption and towards investment.
With inflation expected to remain firm, the apex bank went on to use its liquidity management tool — the cash reserve ratio. Explaining why it brought down CRR, the central bank said the gap between deposit growth and credit growth could widen on the back of the seasonal pick-up in credit demand in the second half of the year.
Credit growth in the banking system is currently hovering at 16.7 per cent, while deposit growth stands a shade above 14 per cent.
This coupled to outflows on account of advance tax payments and the onset of festival-related currency demand could put more pressure on liquidity over the next few weeks. Festival season usually sees currency in the hands of people rising as they withdraw cash from banks.
The RBI indicated that under such conditions, bringing down CRR was necessary for appropriate liquidity management and enabling adequate flow of credit to the productive sectors of the economy.
More importantly, the RBI struck a dovish but cautious outlook when it said that taking the economy to a higher sustainable growth trajectory required a concerted policy action across a range of domains, a process to which last week’s actions made a “significant contribution”.
Significantly, it said that monetary policy also had an important role in supporting the revival of growth. However, it cautioned that persistent inflationary pressures constrained a stronger response of monetary policy to growth risks.
It said the monetary policy stance would be conditioned by careful and continuous monitoring of the evolving growth-inflation dynamics, management of liquidity conditions to ensure adequate flows of credit to productive sectors and appropriate responses to shocks emanating from external developments.