Rupee’s surge may push RBI to use rare cash tool2 min read . Updated: 20 Mar 2017, 09:36 AM IST
RBI may consider raising the cash reserve ratio for the first time since 2010 if deposits accumulated due to demonetisation don't flee over the coming months
Mumbai: The rupee’s surge and a banking system awash with funds will shift focus to a little-used tool in the Reserve Bank of India’s arsenal before next month’s policy review.
The RBI may consider raising the cash reserve ratio for the first time since 2010 if deposits accumulated due to November’s cash ban don’t flee over the coming months, economists say. Banks are holding a near-record Rs5 trillion ($76 billion) of surplus cash, according to the Bloomberg Intelligence India Banking Liquidity Index, limiting the RBI’s ability to buy dollars and curb rupee gains to avoid further increasing liquidity.
This complicates matters for governor Urjit Patel, who shifted the monetary stance to neutral last month from accommodative as inflation accelerates. A stronger rupee would help rein in price pressures but runaway gains could slow a recent export recovery by making shipments less competitive.
“If the surplus liquidity that we are seeing becomes more of a permanent nature, we can see the RBI resort to a cash reserve ratio hike," said Indranil Pan, chief economist at IDFC Bank Ltd in Mumbai. He, however, does not expect such an increase at the RBI’s 6 April review.
The CRR is the amount of deposits banks need to maintain as reserves. It was last raised in 2010 when India saw record foreign inflows into its stock market.
This time the influx is homegrown: bank deposits have surged since November after Prime Minister Narendra Modi’s clampdown on cash. Some of the money could be converted back into cash since the RBI removed withdrawal restrictions last week, but the country’s largest bank estimates that as much as half of it could stay back.
While the RBI has been using a slew of instruments including reverse repo operations and cash management bills to sterilize the inflows, these come at a cost. Citigroup Inc. estimates the government will spend Rs6,000 crore in the year through March to pay interest and any more steps by the RBI to absorb the cash risk lowering its dividend to the government.
The CRR, on the other hand, is interest-free.
“A hike in the cash reserve ratio could once again become an option if the surplus liquidity conditions persist," Samiran Chakraborty, chief economist for India at Citi, wrote in a 7 March report.
The rupee has gained about 2% to a 16-month high in March after Modi’s landslide state election win, outperforming its Asian peers and all but five of the world’s emerging-market currencies. Patel had said last month that the currency is broadly where it should be and that the RBI intervenes only to curb volatility.
India will attract $55 billion in capital flows in the year through March 2018, part of which the RBI will mop up to boost foreign-exchange reserves by $20 billion, according to Deutsche Bank AG. The intervention will weaken the rupee to 67.5 per dollar by the end of December from about 65.5 per dollar on Friday, the bank predicts, though this is much stronger than its previous estimate of 70 per dollar.
“We expect the RBI to continue managing volatility," Kaushik Das, India economist at Deutsche Bank, wrote in the report. Bloomberg