RBI Cuts CRR by 0.75% From March 10, 2012

The Reserve Bank of India has cut the Cash Reserve Ratio (CRR) by 0.75% to bring it down to 4.75%. This, I think, is the lowest ever.

In order to mitigate tight liquidity conditions, the cash reserve ratio was reduced by 50 basis points in the Third Quarter Review (TQR) of January 2012, injecting primary liquidity of 315 billion into the banking system. The Reserve Bank also continued with the open market operations (OMOs), **injecting primary liquidity of over 1,245 billion** this financial year so far, of which 528 billion was injected after the TQR. Despite these measures, the liquidity deficit has remained large on account of both structural and frictional factors. This was reflected in the net average borrowing under the Reserve Bank's liquidity adjustment facility (LAF) rising from an average of 1,292 billion in January 2012 to 1,405 billion in February. Net injection of liquidity through LAF rose to a peak of 1,917 billion on March 1, 2012, though subsequently it declined to `1,273 billion on March 7, 2012. Further, the liquidity deficit is expected to increase significantly during the second week of March due to advance tax outflows and the usual frontloading of cash balances by banks with the Reserve Bank. Thus, the overall deficit in the system persists above the comfort level of the Reserve Bank. Accordingly, it has been decided to inject permanent primary liquidity into the system by reducing the CRR so as to ensure smooth flow of credit to productive sectors of the economy.

That means the RBI injected 1.25 lakh crores into the system buying Government bonds. And yet, the repo offtake – the amount the banks borrow overnight from the RBI – was more than 1.2 lakh crores.

The last time the CRR cut (of 0.5%) was supposed to inject liquidity of 32,000 cr. into the system. It simply didn’t happen, because with that, plus another 52,800 cr. of bond buying after the Third Quarter Review, repo offtake continued to be extremely high. Will this change things?

The cash reserve ratio is a percentage of deposits (in tech terms, “Net Time and Demand Liabilities”) that banks are supposed to keep, interest free, with the RBI. They can’t lend this out. In practice it works like this. They lend what they want to lend, and if they fall short of the CRR they just borrow from the repo window. The total lending is governed by different other pieces of regulation – the Capital Adequacy Ratio, Priority Sector Lending requirements, sector limits etc., so the CRR is less important.

In effect, while this helps the banking system from having to borrow that much, you have to wonder what happened that took repo lending to that extent every day. Still, the liquidity issue isn’t currently showing signs of serious stress (because call money is still around the 9% range, and short term CDs are around 10-10.5%).

The RBI mid-quarter review is on the 15th of March, and the CRR cut was supposed to happen then. Some people surmise that there will be a rate cut on Thursday, which somehow doesn’t make sense to me. (why will RBI do TWO huge changes within a week, unless there’s a crisis? There doesn’t seem to be a crisis.)

Rumours of this were already there during the day – the Bank Nifty went up over 3.5% today.