The Reserve Bank of India (RBI), which has reduced the cash reserve ratio (CRR) by 125 basis points since January, has flared up the debate whether the central bank is now interpreting the tool in a different way.
CRR — the proportion of deposits that banks have to keep with RBI — is a regressive tax on the lenders, as the CRR balance with the central bank does not earn any interest. In recent times, RBI has used CRR as a monetary policy tool, that is, a reduction in the ratio is seen as infusing liquidity into the system to boost growth.
However, in January, when CRR was reduced by 50 basis points amid inflation staying above the central bank's comfort zone, and RBI saying its stance remains anti-inflationary, the question was asked whether CRR is now seen as merely a liquidity tool.
"The CRR is always understood as a monetary policy tool and any change in the reserve ratio is perceived to be signalling a change in the monetary policy stance," Rupe Rege Nitsure, chief economist, Bank of Baroda, said.
According to Nitsure, RBI had to resort to a CRR cut due to the persistent liquidity deficit, which become "structural" in nature during the last quarter of the previous financial year, and started interfering with the smooth sailing of the government's borrowing programme.
"Unfortunately, this created a confusion among the market participants, as the CRR cut is always seen as the reversal of a monetary policy stance and everybody expected an immediate reduction in interest rates," she said.
Following the CRR cut in January, and then in February, yields on the 10-year benchmark government bonds eased on the hope that interest rates have peaked and a rate cut is around the corner. RBI, however, disappointed the street by holding the rates during the mid-quarter review in March and sounded a hawkish note. The RBI's March statement, along with the high government borrowing numbers announced during the Budget, hardened bond yields.
However, there is also a view that CRR should not be seen as either of the tools.
