One week after unveiling a measureless monetary policy review, the Indian central bank on Saturday cut its policy rate, the cash reserve ratio (CRR), or the portion of deposits that commercial banks are required to keep with it, and the statutory liquidity ratio (SLR), or the portion banks need to invest in government bonds. The steps are meant to increase banks’ resources and ease constraints on credit.

Apart from these, RBI has announced many more measures, including a Rs40,000 crore three-month refinance facility for banks and a buyback of government bonds offered under the market stabilization scheme (MSS). These bonds are not part of the government’s annual borrowing programme. They were floated by RBI in the past few years to soak up excess liquidity generated by its dollar buying to stem the rise of the local currency. For every dollar it had bought, an equivalent amount of rupee flowed into the system. Now, the situation has reversed and RBI has been continuously selling dollars, sucking out rupee liquidity. The buyback of the so-called MSS bonds will release liquidity. Along with the SLR cut, the central bank has also allowed banks to borrow up to 1.5% of their SLR holdings—Rs60,000 crore—temporarily to meet the cash requirements of mutual funds and non-banking finance companies.

What has changed between 24 October, when RBI announced its mid-year review of monetary policy, and now? The overnight call money rate that dropped to about 6.5% following a cut in CRR and policy rate in the third week of October crossed 20% last Friday as liquidity tightened again, worsening the growth prospects for the economy, while the wholesale price-based inflation dropped below 11% for the first time since May. Then there was a report by the industry chamber Assocham that forecast a 25-30% loss in jobs in certain sectors after Diwali (it was subsequently withdrawn). Globally, there have been a series of rate cuts by central banks. The US Federal Reserve took the lead and it was followed by five Asian central banks—in China, Hong Kong, South Korea, Taiwan and Japan. The Bank of England and the European Central Bank, too, are expected to cut their policy rates sooner than later.

This explains the RBI decision to cut its policy rate but what’s the rationale behind the cut in CRR and SLR? Why didn’t the central bank pare the level of CRR and SLR on 24 October when it reviewed its monetary policy?

The sudden rise in the overnight call money rate and the tightness in liquidity should not come as a surprise to RBI. Traditionally, the Indian financial system witnesses this during Diwali as consumers withdraw money from banks and keep the cash with them for festival shopping. The amount of “money in circulation", as this is called in monetary jargon, during the festive time varies between Rs15,000 crore and Rs20,000 crore. Another contributing factor to the tightness is a string of bank holidays during the time. As these holidays are not uniform across India, banks tend to keep more cash with them to meet consumer demand. Finally, RBI’s massive dollar sales are drying up rupee liquidity. In fact, in seven days between 17 October and 24 October, India’s foreign exchange reserves dipped by a record $15.4 billion. This means that at the current exchange rate, RBI had drained close to Rs77,000 crore from the system by selling dollars. So, a CRR cut was inevitable, but why did RBI refrain from doing this in its October policy announcement?

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The cut in SLR, too, has not surprised the market but the timing of the reduction strikes a discordant note. A week ago, RBI left it unchanged and defended the action, saying a higher SLR is symbolic of the safety of the Indian banking system as a bank’s investment in government bonds can be liquidated at a short notice and generate cash to meet depositors’ demand. Along with a high capital adequacy ratio, reserve requirements such as CRR and SLR lend strength to the Indian banking system. Then, why the sudden change in approach?

RBI governor D. Subbarao had last week said he could not let his guard slip on inflation but now it’s clear that concerns over inflation have been thrown out of the window and growth and financial stability are higher on the central bank’s priority list. With global commodity prices declining and oil prices going down steadily, India’s inflation rate will fall rapidly in the next few weeks and there will probably be one more round of rate cut this month as the government is expected to cut the administered prices of petrol and diesel before state elections start in November.

There is nothing wrong in RBI’s focus on growth and financial stability that prompted the aggressive cuts in the policy rate and reserve requirements. In fact, they are in sync with Subbarao’s commitment to respond swiftly in an evolving situation. But was there enough provocation for such measures over a weekend? Did the growth prospects dramatically deteriorate in the past week? Was the financial stability massively threatened in the last few days? It’s difficult to justify RBI’s inaction on 24 October and the series of measures a week later. One hopes that the Prime Minister’s Office and the finance ministry aren’t calling all the shots. In abnormal times, coordination between the central bank and the government is fine, but if the trend continues, RBI risks losing its clothes.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to To read all of his earlier columns, go to