RBI’s Cash Reserve Ratio Hike: Wielding The Blunt Drainer
The RBI opted to use the cash reserve ratio tool as it saps liquidity at no cost: Crisil
The Reserve Bank of India has decided to use a blunt tool to impound deposits received by banks between September 16 and November 11 by imposing a 100 percent cash reserve ratio (CRR) requirement, said a CRISIL Research in a report on Monday.
A surge in deposits into the banking sector had led to a free fall in bond yields in India, which, in turn, led to pressure on the rupee as foreign investors chose to book profits on their investments in Indian debt. Foreign investors have sold $2.4 billion in the debt markets since November 9. The rupee tumbled to an all-time low of 68.86 against the U.S. dollar last week, driven partly by outflows along with a stronger dollar and prospects of a U.S. rate hike.
To tackle this surge, the RBI hiked CRR on incremental deposits between September 16 and November 11, but said that this was a temporary measure. In an interview to wire agency PTI on Sunday, RBI governor Urjit Patel said that the CRR hike was required as the government is yet to hike the limit for bond issuances under the market stabilisation scheme (MSS). The limit for MSS bonds was set at Rs 30,000 crore in the budget.
The Reserve Bank of India is trying to neutralise two consequences of demonetisation using a blunt tool: one, by raising the cash reserve ratio (CRR) to 100 percent of net demand and time liabilities (NDTL), it will drain excess liquidity temporarily; and, two, such a giant mop-up will support the 10-year government bond yield, which fell below the repo rate on Friday.DK Joshi & Dipti Deshpande, CRISIL
Implications Of The Move
The immediate impact of this step will be a tightening of liquidity conditions and a rise in bond yields, said CRISIL. The agency, however, highlighted that more liquidity is expected to flow in which would also need to be managed.
The decision to withdraw Rs 500 and Rs 1,000 currency notes from circulation has sucked out 86 percent of the currency by value. This works out to about Rs 15 lakh crore. A large chunk of this (barring the amount that stays out of the banking sector) will flow into banks, adding to banking sector liquidity.
The other impact is on interest rate transmission. Banks could delay cutting their lending rates given that they have promised at least 3-4 percent interest rate to savings account depositors, but will be not be receiving any interest on the deposits impounded for CRR.DK Joshi & Dipti Deshpande, CRISIL
Why Use CRR As A Tool?
The RBI has four tools to drain liquidity – cash reserve ratio, reverse repo operations, open market operations and market stabilisation scheme.
At this stage, the RBI opted to use CRR as it saps liquidity at no cost, said CRISIL.
The CRR is a relatively blunt instrument in that, it immediately saps liquidity at no cost to it (RBI) whereas it pays 5.75 percent for reverse repo auctions. Similarly, the CRR will instantly force Rs 3.4 lakh crore out of the banking system, whereas reverse repo auctions require the banks to opt for it and therefore, does not have an immediate impact. Also, the stock of G-secs with the RBI, necessary to conduct reverse repo operations, is limited. So far, the RBI had been conducting reverse repo auctions to siphon out excess liquidity from the banking system.DK Joshi & Dipti Deshpande, CRISIL
Between November 8 and 25, funds parked by banks with the RBI under reverse repo auctions surged 10 times to Rs 1.5 lakh crore. “The deluge is so humongous and unprecedented that the RBI chose CRR over more nuanced measures,” said CRISIL while adding this is a temporary solution.
