RBI cuts Indian banks' reserve ratios

The Reserve Bank of India surprises markets with a 75bp reduction in the cash reserve ratio ahead of a key policy meeting this week.
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RBI's cash reserve ratio is at its lowest level since 2004 (AFP)
<div style="text-align: left;"> RBI's cash reserve ratio is at its lowest level since 2004 (AFP) </div>

In a surprising move, the Reserve Bank of India (RBI) reduced its cash reserve ratio (CRR) by 75bp after market hours on Friday, cutting it to 4.75% from 5.5%, effective today.

Consensus expectations were for a 50bp reduction ahead of the key March 15 policy meeting, and total cuts of 100bp for the whole of this year.

It was the first time the RBI had cut the CRR — the level of deposits banks have to set aside — outside of a policy meeting since July 2010. It last cut the ratio by 50bp on January 24, and it is now at the lowest level since 2004.

The RBI hiked interest rates by 3.75 percentage points in 13 separate steps between March 2010 and October 2011 to combat inflation; it is now at the beginning of its loosening cycle.

India’s annual economic growth slowed to 6.1% during the quarter to December 2011, its slowest pace in almost three years. Meanwhile, in January headline inflation fell to its lowest level in two years. The rupee is up around 6.5% so far this year, after declining 16% against the US dollar in 2011.

According to Tushar Poddar, economist at Goldman Sachs, the move will inject about Rs480 billion ($9.8 billion) of liquidity into the banking system. Liquidity this month tends to be tight because of advance tax flows ahead of the March-end of the fiscal year.

The aim is to prevent cash shortages in the banking system further harming economic growth.

Poddar doesn’t expect further action by the RBI at the policy meeting, and believes that the central bank is likely to hold back from cutting the repo rate until it can assess the government’s plans for fiscal consolidation and its borrowing intentions in its Union budget announcement on March 16.

Instead, he expects repo rate reductions of 150bp in fiscal year 2013, with 125bp of these happening in calendar year 2012.

“This has largely been driven by the earlier-than-expected improvements in global financial markets and liquidity, and the rally in commodity prices, especially oil,” Poddar wrote in a note on Friday.

On the other hand, India’s growth “is surprising on the downside, while inflation and core prices are coming off”, largely due to weak domestic demand.

The main risk to his view is rising oil prices, as every $10 increase in oil prices has a direct impact of 0.4% on headline wholesale prices.

“Indeed, this is a key reason why we believe the RBI would prefer to wait and assess oil price increases before easing policy meaningfully,” he wrote.

Already this year, other Asian countries including China, have loosened monetary policy either by cutting reserve requirements or lowering key reference interest rates.

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