The 75 basis points (bps) cut in banks’ cash reserve ratio (CRR) last Friday is the second policy action outside a scheduled meeting of Indian central bank ever since D. Subbarao took over as governor in 2008 amid the global credit crunch. The first one was in July 2010 when he raised the policy rate by 25 bps.
One basis point is one-hundredth of a percentage point.
It was widely expected that the Reserve Bank of India (RBI) would cut CRR ahead of its mid-quarter review of monetary policy, slated for 15 March, to infuse liquidity into the system ahead of advance tax outflow in mid-March, but the quantum of cut had an element of surprise, keeping in mind Subbarao’s penchant for so-called baby steps. CRR is the portion of deposits that commercial banks need to keep with the Indian central bank. A 50 bps cut would have infused around Rs 32,000 crore. A 75 bps cut, which will bring down the level of CRR to 4.75%—a quarter percentage point higher than its historic low of 4.5%—will infuse Rs 48,000 crore, little less than what Indian firms will pay as advance tax on their estimated profits for the current quarter.
In January 2010, when RBI started its rate tightening cycle, it had raised banks’ CRR by 75 bps. Before that, in October 2008, when the Indian central bank rushed to make the monetary policy ultra-loose to ward off the impact of the collapse of US investment bank Lehman Brothers Holdings Inc., CRR was cut twice by 100 bps each in quick succession. Under banking norms, CRR can go down to any level. If the cash crunch continues, there will be more cuts in CRR, but certainly not this week when RBI reviews its policy.
Given a choice, RBI would have announced the cut on 15 March, but it had to advance it to take care of the advance tax outflow. Any CRR cut takes effect from the beginning of a reporting fortnight. The so-called reporting fortnight ends on the second and fourth Friday of every month and banks need to keep their CRR on the basis of this. The first fortnight of March ends on 9 March and the new CRR level takes effect from 10 March. Had RBI not done so, the next effective date would have been 24 March—after the second reporting Friday in March. By that time, the liquidity crunch in the system would have been acute.
The systemic liquidity crunch which hit a historic high in early March—Rs 1.92 trillion—has come down but it will be under strain after the outflow of advance tax.
By going in for a 75 bps cut, RBI has ensured that till its April policy—the annual policy for fiscal 2013—it won’t announce any more CRR cuts, even though it can continue with bond buying or the so-called open market operations to infuse liquidity. Just a fortnight before the fiscal year ends, banks will not rush to cut their loan rates, but the rates of short term 90-day commercial papers and certificates of deposits will definitely come down and the overnight call money rate will probably not rise beyond 8.5%.
Will the 15 March review be a non-event? To some extent, it depends on the latest inflation numbers to be released on 14 March. Wholesale price inflation dropped to 6.55% in January and non-food manufacturing inflation, the proxy for core inflation, dropped to 6.67%. Both will be lower in February, but RBI may still like to wait to announce a rate cut since high oil prices and a rise in other commodity prices pose a threat to inflation. The Indian central bank would probably prefer to wait and watch how the government approaches fiscal consolidation in the Union budget and the trajectory of oil prices before taking a call on rate cut.
If inflation continues to go down and oil prices stabilize, one can expect a 25 bps rate cut in April and probably another round of CRR cut by an identical margin.
Strange priorities
An RBI panel to redefine the composition of the so-called priority sector lending of banks has recently proposed to sharply raise the target of foreign banks for such loans from 32% to 40%.
Headed by Union Bank of India chief M.V. Nair, the panel has made many other recommendations, including giving half of banks’ mandatory agriculture loans to small and marginal farmers in stages by 2015-16. Banks are required to disburse 18% of loans to agriculture. This means, 9% should go to small and marginal farmers. RBI will accept comments from the public on the committee report till 31 March. Under current norms, 40% of bank loans go to the priority sector, including agriculture, exports and weaker sections. For foreign banks, this target is 32%.
Instead of redefining the components of priority sector loans in sync with changing times, the panel went for an easier option—raising the level of credit flow to agriculture and small industries by suggesting foreign banks should lend more to such sectors. The combined loan book of Standard Chartered Bank Plc, Citibank NA and The Hongkong and Shanghai Banking Corp Ltd in India was around Rs 1.17 trillion in March 2011. An 8-percentage-point rise in credit flow to the priority sector by the three—from 32% to 40%—will ensure about Rs 10,000 crore extra credit to the sector. What’s the big deal? Is the recommendation worth pushing for when foreign banks do not have enough branches in India? I also hope that the panel has done its homework on how many small and marginal farmer borrowers the banking system will need to meet the 9% sub-target for agriculture loans.