Mumbai, Dec. 8: In a late evening move that took everybody by surprise, the Reserve Bank of India (RBI) raised the cash reserve ratio (CRR) by half a per cent to 5.50 per cent.
CRR is that portion of banks’ deposits which must be maintained with the RBI. The increase is an attempt by the central bank to wring out excess liquidity within the financial system that could otherwise stoke inflation.
The 50 basis points CRR hike will take place in two stages and will drain close to Rs 13,500 crore out of the banking system.
The CRR will first be raised by a quarter of a percentage point to 5.25 per cent from December 23; a similar rise will come into effect from January 6. The CRR has been unchanged for 26 months. The RBI had last raised the CRR by half a per cent in September 2004.
There were two critical factors that prompted the central bank to take this move. First, there has been a robust demand for loans from banks, with advances growth topping over 30 per cent for the past three years. Secondly, money supply in the system has also been running over RBI’s own estimates. Therefore, the RBI wants to ensure that too much cash does not chase too few goods, leading to higher inflation.
Explaining the reasons why it opted for the surprise move that bankers had not anticipated, the RBI said there had been significant developments, particularly on the domestic front. Apart from GDP growing at 9.2 per cent during July-September 2006 and 9.1 per cent in the first half of 2006-07, the year-on-year increase in non-food bank credit up to November 24 was 30.1 per cent on top of an increase of 31.1 per cent a year ago.
Moreover, the year-on-year money supply growth at 19.4 per cent by November 24 was up from 17.3 per cent a year ago. The RBI also pointed out that yearonyear inflation had risen from 4.1 per cent at endMarch 2006 to 5.3 per cent as on November 25 ( ).
The RBI said that though the recent reduction in prices of petrol and diesel will moderate inflation, the overall impact on inflation expectations still requires to be monitored and moderated. It is also estimated that the surplus liquidity in the system is close to Rs 30,000 crore.
Analysts add that in addition to outflow from CRR, advance tax outflows later this month could further crimp resources in the banking system.
Senior bankers were not immediately available for their comment on the CRR hike. The possibility of a jump in interest rates is not ruled out.
“The main messages which the RBI is sending through this strong move is that it wants to curb the rapid credit growth and control inflation expectations. The central bank has always been telling banks to adjust their credit growth, but to no avail. As banks do not get interest from the RBI on the CRR balances, it is highly likely that they could raise interest rates to compensate for this sudden hike,” a treasury chief from a private sector bank pointed out.
He added that the bond markets would witness a sharp fall when they open on Monday. It is also feared that mood in the stock markets will also be hit. Incidentally, the BSE sensex today fell by over 172 points. With CRR now slated to rise to 5.5 per cent, it will be the same that prevailed six years ago.