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CRR cut: RBI's weekend surprise - Views on News from Equitymaster
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  • Mar 9, 2012

    CRR cut: RBI's weekend surprise

    India's central bank seems to have had it enough as far as liquidity in the banking system is concerned. Late Friday evening, when the people were rushing home and eagerly awaiting the weekend, India's central bank was hard at work. It chose to spring a surprise on the unsuspecting public. And quite a big one at that. The Reserve Bank of India (RBI) announced that it has decided to reduce the cash reserve ratio (CRR) of scheduled banks by 0.75% from 5.5% to 4.75%, effective March 10, 2012.

    This surprise move has come around a week before the scheduled monetary policy update. In reducing the CRR, (share of deposits banks must hold with the central bank), the RBI has tried to ease the structural pressures on liquidity. It believes that the CRR cut would be the most effective way to permanently inject liquidity in the system. With this move around Rs 480 bn of liquidity is expected to be injected into the system.

    Why now?

    Banks have been paying a premium for liquidity in the money market. Plus Rs 400-600 bn is expected to flow out of the system and into government coffers as companies pay advance tax. Credit demand is also expected to pick up towards the end of the fiscal as banks try and meet their year-end targets. This would once again put pressure on liquidity. The current liquidity in the system is well below RBI's comfort level, hence the sudden move to rectify matters.

    This move also seems to have come on the back of poor economic growth numbers coming out of India currently. GDP growth has slowed considerably and is way off target. IIP numbers are also dismal. Besides, the fact that inflation has mellowed down a great deal also seems to have helped matters.

    What to expect going forward

    The RBI's monetary policy is less than a week away. We believe that this review may just be a non-event as the 'big move' has already been made. We believe that the central bank would do well to wait before making any decisions regarding cutting policy rates. The RBI may wait for the Union Budget to be released before it makes any concrete decisions. The Budget incidentally releases the day after the RBI's policy update.

    We would like to wait for next week to see the RBI's stance on growth and inflation. However this CRR cut, and the previous one in January has clearly signaled that the central bank is worried about growth in the system. While policy rates have not yet been eased, the CRR cut may just set the tone for FY13. With less pressure to park funds with the RBI, banks may be willing to lend more and thus growth prospects may better.

    All in all, this surprise move was more than welcome. With the March 15th monetary policy likely to be a non-event, all eyes are now on Mr Pranab Mukherjee and the Union Budget.

      Rahul Shah (Research Analyst), Managing Editor, Microcap Millionaires has led the team from the front in developing some of our most stringent and rewarding research processes. As per his own admission, the turning point in Rahul's life as a financial analyst came a few years back when he got introduced to the works of Warren Buffett and Charlie Munger. From Buffett, he understood the value of investing in good quality business with powerful moats and strong management teams. Charlie Munger on the other hand inspired him to be a lifelong learner and use mental models in order to arrive at the crux of matters across most disciplines. Rahul firmly believes that in order to be successful at investing, you have to do the big things right and possess a great temperament and a contrarian streak.



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