Markets were primed to expect a status quo announcement during the run-up to the policy. There was some speculation about a cash reserve ratio (CRR) cut – although not widely expected. Every cut in CRR at this juncture might have sent the wrong signals on its inflation fighting credentials – or so was the received wisdom.

But the Reserve Bank of India chose to bite the bullet and effect a 50 bps cut in CRR. The RBI Deputy Governor, Dr Subir Gokarn, provided the central bank's logic to the decision in an interview with Business Line .

Excerpts:

The CRR cut releases Rs 32,000 crore. But the liquidity deficit is of the order of Rs 1.3 lakh crore? Isn't the relief rather inadequate – because banks will continue to borrow in the repo window?

The change in CRR does gives them a much large cushion when it comes to accessing the repo window. When the deficit is around Rs 1.3 lakh crore a day, some banks are pushing against their holdings of SLR securities.

The system as a whole is quite liquid in that sense. But day-to-day reliance on repo, although it means there is no liquidity crunch as such, because we are not rejecting any offer, means that you are doing credit planning on a day-to-day basis. The CRR cut offers a little more comfort, a little more permanent change in the cash position. It frees up resources and makes your credit planning a little more easier and allows for banks to think in terms of longer-term credit commitments.

Banks as a whole seem to have excess SLR. Besides, they also have investments in mutual funds. If they are still using the repo window, with probably the same banks rolling it over every day, aren't they ending up using repo as a refinance tool – instead of a liquidity adjustment tool?

Nothing stops them from doing that. If they have the eligible securities to borrow from the repo window, they do it. What banks have to decide is where the returns and risks are. And if they are in a situation where the risk-return equation turns adverse when they lend to private enterprise, and they put all their excess money into government securities, which gives us a sense, and is consistent with our view, that the growth momentum is starting to weaken. So there is a portfolio reallocation going on. That really is the situation in the last few months. We have seen a sharp deceleration in credit growth and a correspondingly sharp increase in the investment-deposit ratio. Banks are finding it more attractive to put their money into government securities which are giving them reasonable risk-free return.

That is what the change in the policy cycle will ultimately address - of bringing credit allocation back to financing commerce. Our objective is not to determine what they will fund but make it easier for them to fund – to move to a more predictable, longer term assessment of liquidity conditions.

It is part of an overall attempt at improving the growth momentum.

> vageesh@thehindu.co.in

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