RBI Reduces CRR
THE Reserve Bank of India has reduced the cash reserve ratio (CRR) of scheduled banks by 50 basis points from 6.0 per cent to 5.5 per cent of their net demand and time liabilities (NDTL) effective from January 28, 2012. As a result of the reduction in the CRR, around Rs. 320 billion of primary liquidity will be injected into the banking system.
Repo Rate: The policy repo rate under the liquidity adjustment facility (LAF) has been retained at 8.5 per cent.
Reverse Repo Rate: The reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, stands at 7.5 per cent.
Marginal Standing Facility (MSF) Rate: The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, stands at 9.5 per cent.
Bank Rate: The Bank Rate has been retained at 6.0 per cent.
In reducing the CRR, the Reserve Bank has attempted to address the structural pressures on liquidity in a way that is not inconsistent with the prevailing monetary stance. Earlier, it was indicated that the cycle of rate increases had peaked and further actions were likely to reverse the cycle. Based on the current inflation trajectory, including consideration of suppressed inflation, it is premature to begin reducing the policy rate. The reduction in the policy rate will be conditioned by signs of sustainable moderation in inflation. However, the persistence of tight liquidity conditions could disrupt credit flow and further exacerbate growth risks. In this context, the CRR is the most effective instrument for permanent liquidity injections over a sustained period of time. The reduction can also be viewed as a reinforcement of the guidance that future rate actions will be towards lowering them.
The timing and magnitude of future rate actions is contingent on a number of factors. Policy and administrative actions, which induce investment that will help alleviate supply constraints in food and infrastructure, are critical. Initiatives to narrow skill mismatches in labour markets will help ease the pressure on wages. The anticipated fiscal slippage, which is caused largely by high levels of consumption spending by the government, poses a significant threat to both inflation management and, more broadly, to macroeconomic stability.
Strong signs of fiscal consolidation, which will shift the balance of aggregate demand from public to private and from consumption to capital formation, are critical to create the space for lowering the policy rate without the imminent risk of resurgent inflation. In the absence of credible fiscal consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending. The forthcoming Union Budget must exploit the opportunity to begin this process in a credible and sustainable way.
Expected Outcomes
The policy actions and the guidance are expected to:
i) Ease liquidity conditions.
ii) Mitigate downside risks to growth.
iii) Continue to anchor medium-term inflation expectations on the basis of a credible commitment to low and stable inflation.
And What Do These Mean?
Bank Rate: Bank rate is the rate of interest which RBI charges on the loans and advances that it extends to banks and other financial intermediaries. Changes in the bank rate are often used by central banks to control the money supply.
Repo Rate: The rate at which the RBI lends money to commercial banks is called repo rate, a short term for repurchase agreement. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.
Reverse Repo Rate: The rate at which banks park their money with Reserve Bank is called the reverse repo rate.
Marginal Standing Facility (MSF) Rate: The Marginal Standing Facility (MSF) Scheme is operational on the lines of the existing Liquidity Adjustment Facility – Repo Scheme (LAF – Repo) i.e. commercial banks can borrow money from RBI. The basic difference between Repo and MSF scheme is that in MSF banks can use the securities under SLR to get loans from RBI and hence MSF rate is 1% more than repo rate.
CRR: Cash Reserve Ratio is the cash parked by the banks in their specified current account maintained with RBI.
SLR: Statutory liquidity ratio is in the form of cash (book value), gold (current market value) and balances in unencumbered approved securities. Apart from CRR, every bank is required to maintain in India at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and unencumbered approved securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR). Present SLR is 24%. An increase in SLR also restricts the bank's leverage position to pump more money into the economy.