India’s central bank frees more money for credit

In a bid to free more money for commercial banks to lend, India’s central bank Friday cut a key rate that determines the amount of funds such institutions have to compulsorily hold as cash against their deposits.

The move, which comes less than a week ahead of Reserve Bank of India’s (RBI) review of the monetary policy for this fiscal here March 15, will release additional liquidity of Rs.480 billion into the system.

This follows the announcement by the central bank that the cash reserve ratio (CRR) for scheduled commercial banks has been cut from the ensuing midnight by 75 basis points to 4.75 percent from 5.5 percent earlier.

“In order to mitigate tight liquidity conditions, the cash reserve ratio was reduced by 50 basis points in the third quarter review of January 2012 injecting primary liquidity of Rs.315 billion into the banking system,” the central bank said.

“The Reserve Bank also continued with open market operation, injecting primary liquidity of over Rs.1,245 billion this financial year so far of which Rs.528 billion was injected after the third quarterly review.”

The announcement came soon after RBI Governor D. Subbarao called on Finance Minister Pranab Mukherjee in New Delhi a few days ago, which was described as routine meeting ahead of policy reviews, but had evoked expectations about a policy intervention.

The central bank took the initiative after it was assessed that the liquidity deficit in the system was expected to increase significantly during the second week of March due to advance tax outflows.

“The overall deficit in the system persists above the comfort level of the Reserve Bank. Accordingly, it has been decided to inject permanent primary liquidity into the system by reducing the CRR to ensure smooth flow of credit to productive sectors.”

Industry bodies have welcomed the move and said that it will help in fighting liquidity crunch in the monetary system.

“We welcome the move by the reserve bank to cut the cash reserve ratio. The move was long expected and will help to negate the liquidity crunch. The CRR cut will infuse Rs.48,000 crore in the system which will match the Rs.60,000 crore advance tax outflows,” Soumyakanti Ghosh, director, economics and research, Federation of Indian Chambers of Commerce and Industry (FICCI).

“We expect the RBI to have some more surprises installed when it comes out with the third quarter monetary review on March 15. This could also be a repo rate cut.”

Another leading business lobby Confederation of Indian Industry (CII) also welcomed the move by the central bank stating that the move will help resolve liquidity deficit and urged the RBI to even cut the key lending rate, also known as repo rate, which it said has the potential to boost economic activity in the country.

“CII, therefore, appreciates that the RBI did not wait for its policy review scheduled later this month. CII would recommend that the RBI should go ahead and cut the repo rate in the March review by 50 to 100 basis points, given that inflation has moderated over the last two months,” said Chandrahit Banerjee, Director General, CII.