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BW Businessworld

First Steps

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The Reserve Bank of India's (RBI) third quarter review of monetary policy addressed banks' concerns about the absence of liquidity. Rather than use more open market operations (OMOs, or buying and selling banks' holdings of securities to smooth out cash shortages), the central bank opted for a more permanent infusion by cutting the cash reserve ratio (CRR) by half a percentage point or 50 basis points.

Most welcomed it; stockmarkets celebrated by jumping more than 240 points on 24 January, and another 82 points the next day. But no sooner than the noise died down, there was a clamouring for more. The CRR cut will inject Rs 32,000 crore into the banking system. But the shortage — the structural liquidity deficit — is more than twice, even three times that, going by the amount that banks borrow daily from the RBI's standing facilities.

While the additional liquidity will ease banks' stretched borrowing capabilities, it will not do much to reduce the cost of money in the real economy; in other words, interest rates will not come down for firms or for individuals.
The RBI did not cut policy rates, though it held out hope that all other things being equal, it might do so in next year's annual policy, due on 17 April.

A rate cut will depend upon the trajectory of inflation, which the RBI expects will fall to 7 per cent by end-March 2012. Food price inflation has already fallen dramatically, but commodity prices (read crude oil) and manufacturing inflation are still uncomfortably high.

Not that many analysts are concerned about that just now.

(This story was published in Businessworld Issue Dated 06-02-2012)