RBI’s move will suck Rs 87,000 crore liquidity from market

India’s retail inflation in March this year was above seven per cent, which is beyond the upper tolerance limit of the Reserve Bank’s legal mandate. Second, India’s wholesale inflation remained double-digit throughout the last financial year, a cause of concern for the policymakers as high wholesale prices will start to reflect in high retail prices.

New Delhi: The Reserve Bank’s decision to increase the cash reserve ratio (CRR) by half a percentage point is likely to additional liquidity worth Rs 87,000 crore from the market, according to economists. According to Soumya Kanti Ghosh, the Group Chief Economic Advisor of India’s largest lender, the State Bank of India, at present the systemic liquidity in the system is still in surplus mode as the net durable liquidity was at Rs 7.2 lakh crore as of May 2 (Monday).

The Reserve Bank’s move to hike the CRR by 50 basis points, from 4% to 4.5% of the net demand and time liabilities that will come into effect from the fortnight beginning on May 21, will absorb at least 12% of this systemic liquidity available in the market. Even if it is not a big chunk of the durable liquidity available in the market but the decision, which is coupled with the decision to hike the benchmark short-term inter-bank interest rate by 40 basis points, will certainly nudge the banks to revise their interest rates to appropriately reflect the risks.

Read:RBI hikes benchmark interest rate by 40 bps to 4.40 pc to contain inflation

Though the monetary policy committee (MPC) has decided to maintain the accommodative stance which means it will retain enough liquidity in the system to support the fragile economic recovery, it has shifted the focus on the withdrawal of the accommodation to ensure that inflation remains within the RBI’s target band of 4%, with a margin of 2% on either side. Some analysts believe that with Wednesday’s rate hike decision, the RBI has signalled to the market that its focus has eventually shifted from supporting the economic growth to containing the inflation as mandated by the Reserve Bank of India Act.

India’s retail inflation in March this year was above seven per cent, which is beyond the upper tolerance limit of the Reserve Bank’s legal mandate. Second, India’s wholesale inflation remained double-digit throughout the last financial year, a cause of concern for the policymakers as high wholesale prices will start to reflect in high retail prices.

Impact of rate and CRR hike

Soumya Kanti Ghosh says that this simultaneous policy announcement of adjusting both the rate and quantum of liquidity is a clever ploy and it will reinforce both the credibility and reputation of the Reserve Bank of India. Several analysts in the past have pointed out that unlike other Central Banks, particularly the US Federal Reserve and European Central Bank, the Reserve Bank was delaying the rate hike decision which was pushing the inflation upwards. In a statement to ETV Bharat, Soumya Kanti Ghosh says the decision for a rate hike will be ultimately good for the banking sector as the risks are getting re-priced properly.

Read:Inflationary pressures likely to continue going forward on geopolitical tensions: RBI