RBI targets inflation with 50 bps CRR hike

The Reserve Bank of India has decided to increase the cash reserve ratio (CRR) by 50 basis points to 4.5%in a bid to clear the liquidity overhang in the system and battle inflationary pressures. The hike in CRR will come into effect from the fortnight beginning May 21, RBI governor Shaktikanta Das stated in the off-cycle monetary policy announcement on Wednesday.

After the April MPC meeting, RBI had made it clear that it will withdraw its accommodative stance and reduce liquidity in the system through a multi-year exercise. Back then, It had rolled out standard deposit facility (SDF) to move ahead in this direction.

CRR refers to the portion of total deposits banks are mandated to keep with the RBI in the form of liquid cash. It acts as one of the liquidity control measures in an economy: the central bank can increase CRR to reduce the liquidity in a system and limit lenders’ credit-giving ability, and vice versa.

“Liquidity conditions need to be modulated in line with the policy action and stance to ensure their full and efficient transmission to the rest of the economy,” Das said during his announcement. “The favourable response of banks as evident in bid-cover ratios of 14-day and 28-day VRRR auctions as well as the USD/INR sell-buy swap auction conducted on April 26 also suggest that system-level liquidity remains ample.”

Since the last MPC announcement in April, banking system liquidity stayed in a comfortable zone. Average surplus liquidity in the banking system — reflected in total absorption through standing deposit facility and variable rate reverse repo (VRRR) auctions — amounted to ₹7.5 lakh crore during April 8-29, 2022.

“Therefore, in keeping with the stance of withdrawal of accommodation and in line with the earlier announcement of gradual withdrawal of liquidity over a multi-year time frame, it has been decided to increase the cash reserve ratio (CRR) by 50 basis points to 4.5 per cent of net demand and time liabilities (NDTL), effective from the fortnight beginning May 21, 2022. The withdrawal of liquidity through this increase in the CRR would be of the order of ₹87,000 crore,” the RBI governor stated.

The ongoing geopolitical tensions have put severe pressure on commodity prices and driven inflation upwards, forcing RBI’s hand to take a proactive approach towards policy normalisation, says Suyash Choudhary, head of fixed income, IDFC AMC.

“It will be recalled that it started over the latter half of last year by suspending outright bond purchases, followed it up with the VRRR tool that set the effective liquidity deployment average rate for banks higher, started to actively and passively pursue balance sheet reduction, and then introduced the SDF facility that effectively created a floor for overnight rates 40 bps higher than the reverse repo,” Choudhary stated.

These have now been extended with a 40 bps repo rate hike and 50 bps CRR hike, he further added.

In an unscheduled meeting, the monetary policy committee unanimously decided to hike policy rates by 40 basis points, taking repo rate to 4.40%, SDF rate to 4.15%, and the marginal standing facility (MSF) rate to 4.65%. The decision came on the back of rising inflation and possible supply chain bottlenecks.

Das, during the monetary policy announcement, warned that inflationary impulses with adverse global price shocks will give further rise to inflation. He also warned that the global economic recovery is losing pace.

“FY23 could see overall policy rates go up by 125-150 bps. The terminal rate may be a tad higher than 5.50%, with the RBI now showing its intent to keep real rates neutral or above. We maintain that the gradualist approach toward liquidity and rate normalization may be challenged by various global and domestic push-and-pull factors,” says Madhavi Arora, lead economist at Emkay Global Financial Services.

“Nonetheless, a huge bond supply in FY23 will require the RBI's invisible hand, implying the return of tactical OMOs, especially as the BoP deficit could soar to $50 billion in FY23. The RBI may neutralise this partly with more CRR hikes if it intends to bluntly reduce banking liquidity,” she further adds.