 "I-CRR move to prevent 'asset price bubble': RBI's state of economy report")
The Reserve Bank of India’s (RBI’s) state of the economy report on Thursday warned of asset price bubbles emanating from excess liquidity in the banking system due to weakening lending standards, while commenting on its recent incremental cash reserve ratio (I-CRR) mandate for banks.
During the August review of the monetary policy, the RBI mandated scheduled banks to maintain an additional 10 per cent CRR on the increase in their net demand and time liabilities between May 19, 2023 and July 28, 2023. The I-CRR mandate came into effect from August 12, and the decision will be reviewed on or before September 8.
The report noted that some recent developments, including the return of Rs. 2000 banknotes overwhelmingly in the form of deposits, had expanded liquidity disproportionately, causing some dissonance with the disinflationary stance of monetary policy, while impeding transmission of policy impulses across the term structure of interest rates.
“The slosh of liquidity also has implications for financial stability in the form of potential asset price bubbles and weakening of lending standards,” the report said.
“As the banking system engages in absorbing this excess liquidity into prudent credit expansion, it is necessary to temporarily pre-empt the surplus liquidity from getting into the cracks,” the report, authored by RBI staffers, including Deputy Governor M D Patra, said.
In the same breath, the report said the I-CRR decision would impound some of the surplus while leaving adequate liquidity in the system for normal banking business.
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The intent of the I-CRR mandate, which is termed as temporary, is to return the impounded funds ahead of advance tax outflows from the banking system and well before the pick-up in demand for bank credit that typically characterised the second half of the year, it said.
In the context of retail inflation hitting a 15-month high in July, the report said, “The vulnerability of the economy to recurring incidence of vegetable price shocks, especially ahead of and during the monsoon, warrants major reforms in perishable supply chains covering transportation networks, warehousing and storage technologies, and value addition processes that damp the amplitude of these swings.”
“The uptick in inflation in its June reading mutated in July, with the unprecedented shock to tomato prices spilling over to prices of other vegetables,” the report said.
Noting that core inflation softened in July, the report said the incidence of supply shocks was not over – “elevation in vegetable prices has extended into the first half of August”.
Accordingly, it said, headline inflation was expected to average well above 6 per cent in the second quarter. The August monetary policy review projected 6.2 per cent inflation for the July-September period.
The report said high frequency food price data for August (up to 14th) showed that prices of cereals and pulses continued to increase in the month.
While edible oil prices continued to decline in July-August, tomato prices, on an average, registered a further increase in August so far, although more recent data indicates some pullback in prices. Onion and potato prices also registered sequential upticks.
“It is noteworthy that despite the sharp pick-up in inflation, the risk of stagflation remains low at the current juncture,” it added.