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Monetary policy: RBI to cancel CRR cut in phases, ensures liquidity

The Reserve Bank of India (RBI) on Friday kept its key rates unchanged, ensured abundant liquidity for the bond market and an “accommodating” position for as long as necessary.

After the policy, the repo rate (at which the RBI lends to banks) is 4 percent and the repo rate (at which it takes money from banks) is 3.35 percent. But the cash reserve ratio (CRR), or the amount of liquidity that banks are required to maintain with the RBI at zero interest, will be reduced to 4% in two phases. As of March 27, it will be raised to 3.5% from the current 3%, and from May 22, the CRR will be normalized to 4%. The CRR was reduced by a percentage point last year due to the Covid crisis, and was due to be canceled in March of this year.

The bond market, however, was upset that no further liquidity measures were announced to ease market pain except for the extension of some past easing. In the budget, the government announced Rs 12 trillion borrowing for the next fiscal year and an additional Rs 80,000 crore this year. Bond yields have risen by at least 15 basis points since then, and the market expected the RBI to announce a timeline outlining a huge amount of borrowing in the secondary market. This does not happen. RBI Governor Shaktikanta Das said the central bank was “committed to ensuring the availability of abundant liquidity in the system and thereby fostering financial conditions conducive to recovery.”

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The RBI has extended some relaxations to banks to allow them to invest more in government bonds. The 22% improved hold-to-maturity (HTM) limit, compared to the usual 19.5% last year, has been extended until March 31, 2023 to include securities acquired between April 1, 2021 and March 31, 2022. Special exemption from permanent marginal installation (MSF) has been extended by six months. Banks can now deduct loans disbursed to new small and medium scale borrowers from their net demand and term liabilities to calculate the CRR, in the event of a loan up to Rs 25 lakh per borrower. The central bank has also postponed the implementation of the last tranche of the 0.625% capital conservation buffer (CCB) to allow banks to benefit from more capital.

Banks can now use funds raised through targeted long-term repo transactions (TLTROs) to lend to non-bank financial corporations (NBFCs), thereby increasing their liquidity.

But the normalization of the CRR was interpreted as an increase, in particular as the central bank was already normalizing its liquidity operations by resuming the reverse repo at variable rate.

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Upset RBI delegates auction

The bond market reacted rather badly to the normalization of the CRR. Bond yields jumped 6 basis points and dealers wanted higher yields at the Rs 31,000 crore auction scheduled after the policy. A furious RBI refused to sell any bond, including the benchmark 10 and 5 year bonds, and the primary dealers or underwriters of the bonds had to buy most of them.

Seeing a stable RBI, bond yields cooled quickly and the 10-year benchmark closed at 6.07%, stable from its previous close.

Senior economists say the reason for the central bank’s discontent was clear.

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“Calling on domestic savers for government bonds is probably ten times more important than inclusion in a global bond index. Because domestic savers never cause an external crisis and constitute a very stable, potentially inexhaustible source of funds for the government, ”said a senior economist consulted by the RBI on various issues. In addition, by letting the HTM category clearing run for another year, the RBI has potentially opened up another Rs 4 trillion of space for banks to invest in bonds, the economist said.

“The CRR was reversible and, in all likelihood, would be replaced by market operations even more open than the 3 trillion rupees last year. There have been many other more subtle liquidity measures, such as extending the Marginal Guarantee Facility (MSF) for an additional year which can be factored into the liquidity coverage ratio, removing the recalculation loans to MSMEs from the CRR calculation… the market should not have panicked, ”said the economist.

In this way, the RBI processed next year’s 12 trillion rupee borrowing plan even before the start of the year, experts said.

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“This RBI is not going to blink, but at the same time it wants to operate in tune with the market towards a common cause, and not against it. Tolerance for performance has certainly not increased and is probably still around 6% like last year, ”another economist said on condition of anonymity.


For now, the Monetary Policy Committee (MPC) is focused on boosting growth. The decision on rates and position was unanimous, the governor said. Since inflation has returned to the tolerance band, “the MPC judged that the need of the hour is to continue to support growth, mitigate the impact of COVID-19 and bring the economy back on a higher growth path, ”he said.

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The RBI has projected real gross domestic product (GDP) growth at 10.5% in 2021-2022, in the range of 26.2-8.3% in the first half of the year and 6% in the third quarter. Inflation was forecast at 5.2% for the fourth quarter of 2020-2021, 5.2-5% for the first half of 2021-2022 and 4.3% for the third quarter of 2021-2022, “with globally balanced risks” .

“The RBI’s optimistic views on the economy along with continued pressures on inflation strengthen our no-cut position for the foreseeable future, despite maintaining an accommodative stance,” said Tirthankar Patnaik, economist chief of the National Stock Exchange.

In a rare departure, the RBI governor also indirectly asked the state and central government to control prices, especially fuel.

The government would review the RBI’s inflation target mandate in March of this year, the central bank said.

The RBI has said it will conduct a full review of the microfinance industry. According to Chandra Shekhar Ghosh, Managing Director and CEO of Bandhan Bank, it has been over a decade since the Malegam Committee reviewed the MFI framework. Since then, the sector has grown considerably. Therefore, a full review of the sector will certainly be timely, ”said Ghosh.