The RBI has surprised many, cutting the cash reserve ratio (CRR) by 25 bps, but not changing the repo rate.

The central bank has explained this as a pre-emptive move — to take care of a rising gap between credit and deposit in the second half of the year and also a likely build-up in currency demand during the festive season.

However, this appears as a very interesting twist in the RBI’s monetary policy stance.

No doubt, it feels constrained to cut the repo rate that could have kicked up some justification for banks to reduce deposit rates. This could have been detrimental in an atmosphere of high inflation, given the debate that a lack of adequate incentives for deposits is leading to a drop in financial savings.

SIGNALLING MECHANISM

The RBI, therefore, chose to use the CRR as a monetary policy signalling device, the use of which was also probably anyway necessitated by the much lower growth in Reserve Money.

The liquidity induced through the CRR measure would also enable reduction of the cost of the banking sector, while creating a possibility for the CD rates to come off further.

Clearly, the RBI has opened up to balancing better the objectives of growth against inflation, having taken cognisance of the recent efforts by the government. However, it still maintains its caution.

Inflation is still on its mind, especially due to likely commodity price pressures arising out of QE3-induced liquidity.

The risk to export growth and a wide CAD remains, as global slowdown is entrenched.

NO CUTS EXPECTED

What can we expect from the RBI, going forward?

The time may yet not be right for a rate cut unless there are clear indications of inflation risks being arrested.

And this is certainly not expected by October. Hence, we see the RBI still holding back on the much anticipated repo rate cuts for some more time.

(The author is Chief Economist, Kotak Mahindra Bank)

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