RBI hikes CRR to 5%

RBI hikes CRR to 5%

In a bid to tame the runaway inflation, the Reserve Bank today resorted to the familiar liquidity-sucking move of raising the cash balance that banks have to maintain with it.

Technically known as the cash reserve ratio (CRR), this cash balance is the portion of deposits that banks need to compulsorily maintain with the RBI and currently stands at 4.5 per cent.

From September 18, the CRR will go up to 4.75 per cent, which will subsequently be raised to 5 per cent from October 2. The central banks sudden move, which took all by surprise, is expected to suck around Rs 7,000 crore out of the banking system.

The RBI move comes a day after the inflation rate hit a four-year high of 8.33 per cent fuelled by a surge in prices of petroleum products and manufactured goods.

The Reserve Bank of India on Saturday stepped in to do its bit towards reining in inflation.

In an indirect admission that inflation is not a supply-side problem, the monetary authority decided to lower liquidity in the system by raising the cash reserve ratio requirement for banks by half a percentage point to 5%.

Significantly, RBI has also said that it will now pay only 3.5% on CRR deposits that banks keep with it, as against 6% till now - a move that could force banks to lend more.

The CRR hike, which comes on the back of four weeks of 7% plus in-flation, will be effective in two stages. With effect from September 18, the CRR will be 4.75% and then 5% from October 2. Till now efforts to contain inflation were restricted to duty cuts. The first monetary measure came on Saturday.

CRR is the money that banks are required to maintain by regulation as cash deposits with RBI. The amount that each bank has to deposit is determined as a percentage of deposits raised by that bank. An increase in the CRR percentage results in a reduction of funds available for lending.

Meanwhile, the bond market reacted negatively on Saturday as prices of government securities fell by a rupee.

Although the hike will take out close to Rs 8,000 cr from the banking system, it will still leave with more than enough cash.

Going by the amount banks have lent to RBI by way of repo, the surplus fund is in the region of Rs 40,000 cr. The real impact on banks will be the Rs 1,788 crore loss of interest income following the reduction of interest rate on cash reserves.

Home loan rates are unlikely to be move in reaction to the CRR. We have no plans to increase rates as the CRR hike affects only banks," said Keki Mistry, managing director, HDFC.

SBI chairman AKPurwar said the bank will not immediately hike interest rates. The second big-gest player, ICICI Bank said there are no immediate plans to raise rates, but will watch the market next week.

"The hike should not have an impact on liquidity since the surplus funds with banks is in the re-gion of Rs 80,000 crore. But we will be watching the situation in the money markets next weeks," said Chanda Kochhar, executive direc-tor, ICICI Bank.

According to Pradeep Madhav, executive vice-president of the bond house IDBI Capital, a lower interest of 3.5% on the CRR balance is also an indication that the repo rate will not be hiked immediately.

"Due to a lower return banks will be forced to lend more aggressively to preserve their spreads," he said.

By resorting to a blunt monetary instrument of CRR, RBI is in a way harking to the past. Around five years ago, RBI had decided to aban-don direct measurers such as CRR to impound liquidity and resort to indirect measures such as open market operations and revision of key interest rates to conduct its monetary policy.

But given the circumstances, a hike in CRR and simultaneous reduc-tion of interest rates enables RBI to achieve all three objectives of re-ducing liquidity, protecting RBI's balance sheet and stabilising interest rates in the money markets.

As a monetary authority, RBI's responsibility includes releasing enough cash to fund growth and absorbing surplus cash when there is a danger of liquidity fuelling inflation. The central bank also has to en-sure that interest and foreign exchange rates do not fluctuate wildly.

RBI can do this in three ways: one by selling or buying government bonds to absorb or infuse liquidity, secondly by varying the repo rate or the Bank Rate -- the rates at which banks lend and borrow from RBI respectively, and finally by adjusting reserve requirements.

RBI's ability to conduct open market operations are restricted since it has run out of government securities. To make up for this, RBI has asked the government to impound money by borrowing through issue of market stabilisation bonds.
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CRR Hike May Not Harden Interest Rates, React Bankers

The decision of the Reserve Bank of India (RBI) to increase cash reserve ratio (CRR) in two tranches totalling 50 basis points is basically aimed at containing rising inflation by checking excess liquidity in the system.

The cut in CRR, which has been taken on review of the current liquidity conditions, should not create a liquidity crunch or lead to hardening of the interest rates in short or medium term as there is an excessive liquidity of around Rs 50,000 crore in the system, feel bankers.

An increase in the CRR will certainly have a negative but not a detrimental effect on the liquidity. There is excess liquidity in the market with the banks parking Rs 40,000 crore in the repo window. Hence, there would be no liquidity crunch in the banks, Centurion Bank country head (treasury) Tarini Vaidya said.

Says Corporation Bank chairman and managing director Cherian Varghese, The hike in the CRR would deprive banks of lendable funds. However, we are not worried, as we are in a position of plenty. The rationale behind this would probably be to control the steadily rising inflation. It would also be to control liquidity situations in the market.

We do not envisage any immediate change in intersrt rates even upto the medium term, unless the RBI changes the repo rate. There will be no significant change in the bond market either. However, banks interest income would be negatively impacted by a hike in CRR.

A hike in CRR will certainly trigger off negative sentiments in the bond market, she said. Prices will decline pushing the bond yeilds up north. Currently the interest rate of the benchmark 10 year bond is 5.95%. This is expected to shoot up to 6.15%, said a private banker.

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