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Once again, the RBI walked down the path of a CRR reduction of 25 bps and did not touch the repo rate. This was explained as a pre-emptive move to take care of the gap between deposit and credit growth of the banking system and a likely drain of liquidity due to a build-up in the currency demand.
The CRR reduction might also be seen in line with RBI’s effort to provide a boost to reserve money. With net foreign exchange assets of the RBI growing at only 5.4 per cent in FY13 till date from a comparative 17.2 per cent last year, the onus of reserve money creation rested on domestic sources of LAF and OMO and now also on CRR.
In effect, CRR has now been opened up as a liquidity management tool, from being looked at only as a monetary policy tool.
No doubt, the RBI has opened itself to balancing better the objectives of growth against inflation.
However, despite revising down its growth estimates for the year to 5.8 per cent from the earlier estimate of 6.5 per cent, if feels constraint to reduce the repo rate immediately.
This is based on the risks to the macro-economy from inflation that has remained high.
TWIN DEFICIT
Further, it sees risks to inflation continuing from persistent supply constraints, likely pressures on rupee due to global financial instability and also an upsurge in both rural and urban wages.
On the other hand, RBI feels that the twin deficit remains a problem and unless this recedes, there could be limited room for monetary policy to respond to growth concerns.
Directionally, the RBI thinks that inflation will ease in the last quarter of the year and there is likelihood of “further” policy easing at that time.
We concur with the RBI on this and pencil in a 50 bps reduction in the repo rate between January-March 2013.
From a bond market perspective, the market is likely to stay long on bonds on this expectation and there is unlikely to be much upside to benchmark yields.
Further easing on the liquidity front via CRR cuts are also likely. And, OMOs could once again become a reality if excess borrowings of the central government are to become a reality.
(The author is President – Group Treasury and Global Markets, Kotak Mahindra Bank. The views are personal.)
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