CRR cut makes no sense

The decision of the Reserve Bank of India (RBI) not to make changes in policy rates but to cut the Cash Reserve Ratio (CRR) by 25 basis points is not understandable in the context of both internal and external economic conditions.

A near-zero growth of industrial production, a steep decline in merchandise exports for the fourth month in a row due to a fall in demand, an inflation rate of 7.55 per cent and continued uncertainties in the external sector are the depressing features of the economy. Core inflation in August 2012 stood at 5.5 per cent -- above the comfort level of RBI.

There would be no respite from price rise till the kharif crops arrive in a couple of months. The RBI statement highlights the insufferable level of inflation and the need to focus on it. How does the CRR cut help in realising the objective?

The RBI review says: “…while growth risks have increased, inflation risks remain. Mitigating the growth risks and taking the economy to a higher sustainable growth trajectory requires concerted policy action across a range of domains, a process to which last week’s actions made a significant contribution.”

Because in the past the Bank prescribed fiscal reforms as preconditions for its policy relaxation perhaps it felt that it had to do something to keep its word.

But what has been announced by Government is not final, given the opposition from all parties, except the Congress. Eventually they are likely to be withdrawn.

When the choice is between the survival of the government and that of the economy, given the narrow vision of politicians that does not extend beyond the next election date, policy makers would prefer the former. The rise in the price of diesel was the right decision taken at a wrong time. It will further aggravate the inflation rate.

The RBI could have waited to know the final position on the reforms front before relaxing the CRR. It also needs to undertake research on the causes of the decline in the growth rates of main economic variables, and how far the high lending rates are responsible for it.

WHY THE HASTE

RBI should evolve a comprehensive concept of liquidity for assessing its shortage or surplus in the economy. The cut releases Rs 17,000 crore to the banking system at a time when the liquidity situation is within the comfort zone of the central bank, as is evident from the operations at its repo window. One important point is the fact that, unlike on many occasions in the past, the advance tax payments till September 15 have not strained the system’s resources.

However, the RBI says that, combined with the seasonal pick-up in credit demand in the second half of the year, 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. It could have waited for the next policy review due only six weeks from now. In any case, it can make changes in CRR between two review dates.

The truth is that there is excess liquidity in the banking sector, as is evidenced by the Statutory Liquidity Ratio.

As on August 31, 2012, it was more than 7.5 percentage points above the required minimum. It is just possible that it will go up further due to the CRR cut.

The C/D (credit/deposit) ratio was 75.11 against the normal 72.25 per cent. Total accommodation provided by Scheduled Commercial Banks by way of credit and investments in commercial paper, etc., in the current fiscal year till August 24 showed a growth of 2.5 per cent, the same as in the last comparable period.

FACILITATE GOVT BORROWING

Investments in mutual funds increased to Rs 258.7 billion, compared with Rs 223.6 billion in the corresponding period of 2011-12.

The CRR cut will not have much of an impact on interest rates in the system. There is not likely to be any reduction since many banks have already done so, both on the deposit and lending sides.

In the past whenever CRR was raised, the burden was borne by the depositor, but he would not get any relief when it was reduced. This asymmetrical experience is likely to repeat itself. This is unfair in the context of the negative real rates he is getting now.

But banks are not worried about real rates since they are in the win-win situation of having a positive net interest margin, even if the real lending rates are negative.

One gets the impression that the release of impounded funds by the RBI is to facilitate government borrowing in the coming days so that it need not undertake the so-called Open Market Operations for some time to come.

The increase in Gross Domestic Product could be sustained only if there is an increase in aggregate demand. It is inflation that is inhibiting the latter.

There are enough anecdotal reports and hard statistics to show how aggregate real demand has fallen to a lower level as a consequence of the general price rise.

Look at the depleted market crowds at the peak of the festival season.

Those who argue for growth over price stability should note that it would be a vicious circle – inflation leading to lower savings, real demand and investment, which, in turn, will bring down the growth of aggregate supply, resulting in a general price rise.

(The author is an economic consultant.)

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