RBI keeps policy rate unchanged, CRR cut by 25bps

The Reserve Bank of India (RBI) on Monday kept the repo rate-the key policy rate-unchanged in its mid quarter monetary policy review, but cut cash reserve ratio (CRR) by 25 basis points to 4.50%. CRR is the portion of deposits that banks keep with the RBI. However, it normally does not earn any interest for banks. The policy action is almost in line with the market expectation.

The central bank's stance indicates that it is worried about the inflationary fallout of the diesel price hike, and would wait for some more time before softening its stance on interest rates. The 25-basis point cut in CRR is expected to release around Rs 17,000 crore into the system.

Banks are currently comfortable with the liquidity situation. In the last couple of weeks, lenders have borrowing below Rs 100 crore through RBI's liquidity adjustment facility (LAF). This is in stark contrast with the LAF level hovering between Rs 75,000 crore to Rs 1 lakh crore 3-4 months back. However, RBI's CRR cut came into effect with a future outlook.

"Going forward, the wedge between deposit growth and credit growth could widen on the back of the seasonal pick-up in credit demand in the second half of the year. This, combined with outflows on account of advance tax payments and the onset of festival-related currency demand, could accentuate pressures on liquidity over the next few weeks," RBI said.

Earlier in the year, RBI decreased the policy or repo rate by 50 basis points in April. It slashed cash reserve ratio by 150 bps so far in 2012. Repo and reverse repo remained unchaged at 8% and 7% respectively. RBI continued with its primary policy focus in "the containment of inflation and anchoring of inflation expectations."

"In April, the Reserve Bank implemented a frontloaded policy rate reduction of 50 basis points on the expectations of fiscal policy support for inflation management alongside supply-side initiatives for addressing the deceleration of investment and growth. As these expectations did not materialise and inflation remained firmly above 7.5%, the Reserve Bank decided to pause in its policy easing in the mid-quarter review of June," the regulator said in its credit policy statement.

The core inflation did not show any sign of relief with non-food manufactured product inflation rose to 5.6% in August as against 5.1% in April. "Even as demand pressures moderate, supply constraints and rupee depreciation are imparting pressures on prices, rendering them sticky," RBI said.

Meanwhile, the banking regulator has hailed the government's latest reform measures. Last week, the government announced a slew of measures to revive the sluggish economy. Those included a hike in diesel price by Rs 5, limiting subsidized LPG cylinders at 6 a year per family, allowing foreign direct investments in aviation and multi-brand retail upto 49% and 51% respectively. It also decided to dilute stakes in public sector units.

"Domestically, growth continues to be weak amidst a negative investment climate; however, the recent reform measures undertaken by the Government have started to reverse sentiments. The Government undertook long anticipated measures towards fiscal consolidation by reducing fuel subsidies and selling stakes in public enterprises," RBI said adding that steps taken to increase FDI should add to both greater capital inflows and higher productivity.