Pranab Mukherjee laudsthe balancing measure

"A step that would help in easing the liquidity situation and spur growth without stoking inflation"

Finance Minister Pranab Mukherjee on Tuesday lauded the Reserve Bank of India's decision to cut the CRR (cash reserve ratio) by 50 basis points as a step that would help in easing the liquidity situation and spur growth without stoking inflation.

The cut in CRR from 6 per cent to 5.5 per cent with effect from January 28 will result in the release of an additional Rs.32,000 crore into the monetary system and thereby ease the liquidity situation.

Commenting on the RBI action, Mr. Mukherjee, who was in Dehradun during the day campaigning for the Congress ahead of January 30 Assembly polls in Uttarakhand, said: “[The Reserve Bank's] announcement should help address the money market liquidity, which had tightened in the past two to three months, while balancing the downside risk on growth and deceleration in moderation of inflation”.

Mr. Mukherjee pointed out that consequent to the CRR easing, banks “will have more money to lend and liquidity will increase. Because of the inflation pressure, they (the apex bank] have not altered the interest rates ... I welcome the decision of the RBI”.

On the RBI statement that a high fiscal deficit was preventing the apex bank from easing interest rates, Mr. Mukherjee noted that while the government had been taking steps, it would unveil measures to tackle the issue in the Budget for 2012-13. “... We want to reduce it by adjusting the fiscal policy, which I am doing ... and I shall [disclose] the essential features in the Budget,” he said.

Echoing similar views, Economic Affairs Secretary R. Gopalan pointed out that the cut in CRR would ease liquidity, reduce the cost of funds and thus provide a boost to growth. “CRR cut ensures that fair amount of money is available, the cost of fund is reduced ... All these things are good to create a growth enhancing impression,” Mr. Gopalan told reporters here.

Prime Minister's Economic Advisory Council (PMEAC) Chairman C. Rangarajan also dubbed the RBI measure as a “wise decision”, to catalyse growth without fuelling inflation. The cut in CRR signals that the next step — provided inflation declines further — is a cut in interest rates. “But reduction of the policy rate will have to depend upon the behaviour of non-food manufacturing inflation. Unless that comes down and give definite signs of a decline, the policy rate cannot be changed. I think that's the real message from the Reserve Bank,” he said.

The RBI's balancing act

  The Reserve Bank of India has managed a delicate balancing act in the third quarter review of monetary policy 2011-12 unveiled on Tuesday. The reduction in cash reserve ratio (CRR) by 0.50 percentage point to 5.5 per cent will somewhat ease the tight liquidity conditions in the money market, while the decision to leave interest rates unchanged sends a clear signal that the apex bank is still not comfortable with the overall picture on inflation. With economic growth visibly slowing down — something the apex bank acknowledges — there was pressure to start the rate reduction cycle. But there are three major worrying factors on the inflation front. First, non-food manufactured product prices continue to be high; much of the drop in inflation in recent weeks was due to a fall in the prices of vegetables and seasonal products. Secondly, suppressed inflation in the form of artificially held down prices of petroleum products is quite significant. Finally, the depreciation in rupee value has also been feeding into core inflation. Given these, it was unrealistic to expect the RBI to embark now on the rate reduction cycle. However, the central bank has done its bit to encourage credit off-take by infusing liquidity (Rs.32,000 crore) through a reduction in the CRR. Despite the RBI's open market operations injecting Rs.70,000 crore over the past two months, money remained scarce, affecting credit flow to borrowers.

So, what are the prospects for the rate reduction cycle commencing soon? Not very bright, it appears. A lot depends on what the government does in the budget for 2012-13. The RBI is clear that the budget should come up with policy initiatives to induce investment and concrete measures for fiscal consolidation, if it is to start pegging rates down. This, especially the latter, is easier said than done. There are several factors that could impact the economy adversely. Not the least of them is the uncertainty in the euro zone, let alone the falling capital inflows in the context of a widening current account deficit. Inflation could once again spiral upwards if fuel prices, especially of diesel, are raised, as they should be. The escalating tensions over Iran portend more trouble, as they could drive up global oil prices forcing the government to pass the burden down the line. Adding wind to the inflationary sails will be a hardening of food prices, especially vegetables, which usually happens with the end of winter. All these, combined with the lacklustre investment climate as evidenced by the declining levels of non-food credit off-take, means that there is enough for the RBI to worry about before it makes up its mind on turning around the interest rate cycle.