3 reasons why the RBI hiked CRR

The Reserve Bank of India (RBI) hiked the cash reserve ratio over the weekend - the percentage of cash deposits that banks have to maintain with RBI – at 100% of the deposits (NDTL) accrued between September 16 and November 11 as incremental cash reserve ratio. An increase in CRR means that banks have to park more money with the central bank and, hence, a higher CRR sucks out liquidity from the banking system.

Here are three reasons why the RBI hiked the CRR, excerpted from a Citi India economic research report, jointly authored by Samiran Chakraborty, chief economist, Citi India and Anurag Jha, economist, Citi India.

FIRST: The surplus in the banking system at Rs 5 trillion (Rs 5-lakh crore) was inching closer to the maximum absorption capacity of the central bank. RBI had Rs 7.5 trillion (Rs 7.5-lakh crore) of g-secs prior to demonetisation drive, which act as collateral to absorb banking system surplus through the reverse repo window. RBI’s estimate of deposit accretion going forward might have prompted them to announce a large CRR hike which would obviate any discussion around RBI running short of g-secs. 

SECOND: The process of putting in place other liquidity absorption measures like issuance of Market Stabilization Scheme (MSS) bonds was taking time, as mentioned by the RBI Governor recently. Issuance limit of MSS bonds for this year was set at Rs 300 billion earlier, which was too small given the liquidity absorption requirement.

THIRD: The strong action could also be aimed at signaling RBI’s reluctance on market interest rates falling too sharply, too soon in the present global context. The surplus rupee liquidity and sharply falling rates was also creating distortions in the forward premia and indirectly impacting the spot  USDINR. This liquidity absorption measure could reverse some of these distortions.

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