The Reserve Bank of India (RBI) on Friday (December 6) cut the cash reserve ratio (CRR) by 50 basis points (bps) to 4% from 4.5% to boost liquidity in the financial system.
CRR is the percentage of a bank’s total deposits that it is required to hold in liquid cash as reserves with the RBI.
RBI’s Monetary Policy Committee (MPC), which was found in Mumbai on Friday. However, the majority kept the repo rate – the main policy rate – unchanged at 6.5% in a 4-2 decision. This is the eleventh consecutive monetary policy in 22 months, which has kept the repo rate unchanged.
Significantly, the policy panel lowered the GDP growth estimate in FY2025 to 6.6% from the previously estimated 7.2%, and revised the retail inflation projection to 4.5% for the current fiscal year from 4.5%.
The six-member MPC has also decided to keep the monetary policy stance ‘neutral’ on policy.
Why was CRR cut?
The decision to cut CRR by 50 bps will free up Rs 1.16 lakh crore in the banking system, increasing banks’ lending resources.
Due to the Reserve Bank’s actions to stabilize the rupee, there has been a decrease in liquidity in the banking system. There has been a lot of dollar selling (by the RBI), which has affected the overall liquidity in the system. In December, liquidity will be further tightened due to advance tax, Goods and Services Tax (GST) payment related outflows and quarter-end debt demands.
It is expected that the banks will benefit from the latest decision of the Central Bank as the banks will not get any interest on this amount kept as CRR from the Reserve Bank. CRR is a tool used by RBI to manage inflation and check excessive lending.
The excess liquidity can be used by banks to lend, which is expected to help spur economic growth. “CRR reduction will free up bank money, which can be used more for lending. Banks are likely to pass on the benefits of this CRR reduction to borrowers. Generally, reduction in CRR is net interest margin (NIM) accretive for banks,” said VRC Reddy, Head Treasury. , Karur Vysya Bank said.
What is the decision to keep the repo rate unchanged?
The 4-2 decision to keep the repo rate unchanged indicates that the policy panel is divided on the way forward given the slowdown in the economy.
RBI Governor Shaktikanta Das flagged persistent food inflation in his explanation for the majority decision.
“Food inflationary pressures will remain in the third quarter of FY25 and start easing in the fourth quarter of FY25. High inflation reduces disposable income in the hands of consumers. The MPC believes that only with durable price stability, we create a strong foundation for higher growth,” he said.
In the last two months, two Union ministers have called for a cut in the repo rate.
Last month, Finance Minister Nirmala Sitharaman batted for “cheaper bank interest rates” to support industries to ramp up and build capacities. And Union Commerce and Industry Minister Piyush Goyal urged the RBI to boost economic growth and reduce interest rates by looking at food prices while deciding on monetary policy.
How are ordinary borrowers likely to be affected by RBI MPC decision?
With the RBI leaving the repo rate steady at 6.5%, all External Benchmark Lending Rates (EBLR) linked to the repo rate will not increase, giving relief to borrowers as their Equated Monthly Installments (EMIs) will not increase.
However, as the liquidity in the banking system will increase, there is a possibility that the rate of deposits will decrease to some extent when the CRR is cut.
Lenders (banks and financial institutions) may increase interest rates on loans that are linked to the marginal cost of funds-based lending rate (MCLR), where the full transmission of the 250-bps increase in the repo rate between May 2022 and February 2023. didn’t happen
In response to a 250-bps increase in the policy repo rate from May 2022, banks have revised their repo-linked external benchmark-based lending rates (EBLRs) upwards by the same magnitude.
The average 1-year marginal cost of funds-based lending rate (MCLR) of scheduled commercial banks has increased by 170 bps from May 2022 to October 2024.
Why has the MPC cut the economy’s growth forecast?
The MPC cut its GDP growth forecast to 6.6% from 7.2% after the economy slowed in the second quarter.
In the October, August, and June MPC announcements, the RBI maintained its GDP growth estimate for 2024-25 at 7.2%, with slight variations in quarterly growth.
The recession bottomed out in the second quarter, and has recovered since then – driven by festive demand and rural consumption, Governor Das said.
Recent data released by the National Statistics Office (NSO) showed the country’s real gross domestic product (GDP) fell to a seven-quarter low of 5.4% in July-September 2024. This compares with an increase of 6.7% in April. -8.1% in the June 2024 quarter and July-September 2023 period.
And what did the MPC say on inflation – and why?
The policy panel has raised the inflation estimate for the current financial year to 4.8 percent from 4.5 percent.
Consumer price-based inflation (CPI), or retail inflation, reached a 14-month high of 6.21% in October 2024, compared with 5.5% in September.
The MPC maintained a cautious stance, highlighting limited room to cut rates to meet above-target inflation. Inflation levels are well above the RBI’s tolerance level.