The move to cut CRR by 50 basis points and not the repo rate is because it is not prudent and practical to reduce the interest rates when there is liquidity shortage in the banking system.
Published Dec 07, 2024 | 9:29 AM ⚊ Updated Dec 07, 2024 | 9:29 AM
RBI, Delhi
The Monetary Policy Committee (MPC) has decided by a 4:2 majority to keep the policy repo rate (the rate at which the banks borrow money from RBI) unchanged at 6.5% for the 11th time.
External members Dr Nagesh Kumar and Prof Ram Singh voted for a reduction in the repo rate by 25 basis points.
RBI Governor Shaktikanta Das and the MPC, perhaps, faced a Hamletian dilemma on whether to cut the repo rate or not.
The MPC decision was even tougher than the Covid-19 times, as our economy faced a serious double-whammy situation of runaway consumer price index (CPI) inflation of 6.2% in October 2024, from 5.5% in September (the highest in 14 months).
The ‘culprits’ are the spiralling prices of ‘TOP’ — Tomatoes, Onions, and Potatoes — as part of food inflation, which shot up to 10.8% in October (YoY).
Vegetable inflation, as a standalone, contributed 42% to the surge in CPI inflation.
The unexpected Gross Domestic Product (GDP) nosediving to 5.4% in Q2 (July-September) stumped the RBI forecast of 7%, the central government, economists and analysts who had all projected a Q2 GDP growth of over 6.5%.
The deceleration in GDP was on account of dismal performance with respect to few critical sectors like manufacturing — down to 2.2% from 14.3% in FY24, mining and quarrying, which slipped to negative territory at (-)0.1% as against 11.1% in Q2 FY24.
The worst being the slow down in the central government’s capital expenditure (CAPEX) which is woefully in deficit of over 12% between April -September 2024 vis-a-vis same period, last year.
The RBI governor withstood the pressure by central ministers Piyush Goyal and Nirmala Sitharaman who were batting for ‘rate cuts’ by the RBI to support economic growth.
Shaktikanta Das and the MPC did admirably well in navigating the tricky situation of dealing with spiralling inflation and low economic growth by reducing the Cash Reserve Ratio (CRR) by 50 basis points to 4%. CRR is the share of deposits which banks must park with RBI without earning any interest.
The reduction of CRR of all banks to 4% is in relation to the respective banks’ net demand and time liabilities (NDTL) in two equal tranches of 25 basis points each with effect from the fortnight beginning 14 December 2024. This move will inject liquidity to the extent of ₹1.16 lakh crore into the banking system.
Simultaneously, the RBI increased the CPI inflation forecast for Q3 FY25 (October-December) from 4.8% to 5.7%, Q4 (January-March) from 4.2% to 4.5% and for the full year FY25 to 4.8% from 4.5% and reduced the GDP growth forecast for FY25 from earlier 7.2% to 6.6% (Q3 6.8% and Q4 7.2%).
The move to cut CRR by 50 basis points and not the repo rate is because it is not prudent and practical to reduce the interest rates when there is liquidity shortage in the banking system.
The banking system will not have ‘money to lend’ to cope up with the demand for retail home loans, vehicle and gold loans (especially during the festive season till end of January 2025), and MSME/corporate loans, if the repo rate is reduced at this juncture.
Moreover, with the inflation reigning high, the disposable income in the hands of the urban population will be reduced.
So, the RBI deemed it fit and timely to reduce the CRR, make available liquidity of over ₹1 lakh crore and pass the baton to the banks and to the government to do the heavy lifting for the remaining months of the financial year.
The banks will have to seize the opportunity of reduced CRR and do quality lending (otherwise inflation will spill from non-core to core inflation) to manufacturing sector, MSMEs, corporates, housing and real estate sector, which all have taken a serious beating in the Q2 (July – September). This will have multiplier effect in the growth cycle of the economy.
Banks should not take advantage of this situation of excess liquidity to reduce fixed-deposits interest rates, or invest in government bond and debentures to improve their Net Interest Margins (NIMs) and the ‘bottom line’ of their balance sheets for FY25.
The central government (and the states) will have to come out of their post-election mode, heavily prime the economy through aggressive CAPEX in key infra growth sectors (₹11.11 lakh crore is the budget allocation for this year) and kindle the animal spirit to realise reasonably decent GDP growth of over 6% for FY25.
The RBI will be closely monitoring the actions of the central government and the banks, Trump tariff effect post January 2025, central government ‘s budgetary allocations deficit figures for FY25-26 and take appropriate decision on the repo rate cut in its next policy announcement on 7 February 2025.
(S Narendra is a Bengaluru-based Banker, Economist and guest columnist. Views are personal. Edited by Majnu Babu).
