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Business News/ Opinion / Online-views/  Another CRR cut needed
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Another CRR cut needed

Another CRR cut needed

Illustration: Jayachandran / MintPremium

Illustration: Jayachandran / Mint

The Reserve Bank of India (RBI) made it clear on Monday that it was temporarily cutting the cash reserve ratio, or CRR, which is the amount of cash banks have to compulsorily keep with the central bank. The subtext is that RBI will pump money into the local financial system till the current liquidity squeeze eases. It is not a signal that monetary policy is being loosened despite high inflation.

Illustration: Jayachandran / Mint

There are two reasons why there is not enough liquidity in the short-term money market right now. One, companies have paid their advance taxes to the government; this money will later re-enter the banking system, once the government starts spending it. So, money markets usually tighten around this time every year.

But then there has been a second — and unusual — factor this year. Foreign portfolio investors have been selling Indian stocks and the rupee. Fresh inflows through corporate borrowings too have dried up. The dollar shortage has pushed down the rupee and RBI has had to intervene to stabilize the Indian currency. This it does by selling dollars and buying rupees. But such market intervention worsens the funds shortage in the domestic money market.

The central bank has hiked CRR many times since September 2004 to absorb excess liquidity created by strong capital inflows. These inflows have now been replaced by capital outflows. It is natural for RBI to cut CRR.

Will it be enough? The math does not quite work out. The first CRR cut in five years will add around $4 billion to the short-term money market. That is far less than what the central bank has pulled out through its interventions in the foreign exchange market.

In other words, this CRR cut will most likely have a limited effect on short-term liquidity in case RBI keeps selling dollars to defend the rupee. That is why we would not be surprised if a further CRR cut is announced in RBI governor D. Subbarao’s first monetary policy that is due later this month.

And what about policy interest rates? Inflation seems to have peaked and the drop in the global price of oil and other commodities could take some pressure off prices.

But the disappointing first estimates of farm production this year and the persistence of inflation in manufactured goods make us believe that a cut in policy rates is uncalled for right now. We would prefer the central bank to hit the pause button — neither raising nor cutting policy interest rates.

Is the time ripe for interest rate cuts? Write to us at views@livemint.com

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Published: 08 Oct 2008, 12:12 AM IST
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