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Monetary Policy and CRR
Context:
The Reserve Bank of India (RBI) began its three-day monetary policy review on Wednesday, December 4.
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- While there is broad consensus that the repo rate—currently at 6.5%—will remain unchanged, speculation is growing that the RBI may announce a reduction in the Cash Reserve Ratio (CRR).
- The RBI last reduced the CRR during the COVID-19 pandemic in March 2020, lowering it from 4% to 3%.
- Before this, the CRR had remained unchanged for seven years. Since then, the CRR has been raised three times, most recently to 4.5% in May 2022.
What is the Cash Reserve Ratio?
- The CRR refers to the percentage of a bank’s total deposits that it must hold in liquid cash with the RBI.
- This reserve requirement, currently set at 4.5%, is a monetary policy tool used to control inflation and regulate excessive lending.
- Banks do not earn any interest on this reserve.
Why Consider a CRR Cut Now?
- Calls for a CRR cut have intensified amid tight liquidity in the banking system and the slowing of India’s economic growth, with GDP growth falling to a seven-quarter low of 5.4% in the July-September 2024 quarter.
- A CRR reduction would indicate the RBI’s willingness to ease monetary policy without altering the repo rate.
- Liquidity conditions have tightened due to the RBI’s interventions in the forex market to stabilise the rupee.
- Since October 1, the rupee has depreciated by nearly 1% against the dollar, prompting the RBI to sell dollars.
- These interventions, combined with outflows related to advance tax payments, GST payments, and quarter-end credit demand, have further strained liquidity.
- The country’s forex reserves have fallen by approximately $45 billion between October 4 and November 22 due to these interventions.
Impact of a CRR Cut
- A CRR cut would enhance liquidity in the banking system, allowing banks to deploy surplus funds for lending.
- This could boost credit availability, spurring economic growth.
- Additionally, banks might pass on the benefits to borrowers, potentially lowering borrowing costs.
- A reduction in CRR is also likely to improve banks’ net interest margins (NIM).
