RBI’s 79-page misreading

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The RBI chose to hike the cash reserve ratio (CRR) by another 25 basis points in its credit policy announcement on Tuesday. This is expected to suck out an additional Rs 8,000 crore of liquidity from the Indian economy. The central bank kept the repo and the reverse repo rates unchanged. Since the repo window has hardly been used by banks in recent times, raising it would not have been an effective instrument to reduce credit growth. An increase in the reverse repo from 6% to above the bank rate, currently also at 6%, would also have been pointless. Any interest rate hike would have increased the interest rate differential further. This has already been pulling in huge amounts of capital since the US Fed started cutting interest rates in July 2007.

On April 17, RBI had already announced an unscheduled CRR hike from 7.5% to 8% in two stages. This has been upped to 8.25%. RBI’s macroeconomic assessment says that reserve money growth was 31% last year. This growth has been due to the high growth in RBI’s foreign exchange assets resulting from its intervention in the forex market. In other words, the credit policy and the earlier CRR hikes are attempts to soak up the liquidity gush caused by RBI’s forex intervention policy.

It is unfortunate that banks, and ultimately their customers, have to bear the brunt of RBI’s sterilisation efforts. Had it not been so busy keeping the rupee weak to satisfy export lobbies, today banks and their customers would not have been forced to pay this tax on the banking system. A higher CRR forces banks to hold more money at unrenumerative rates with the RBI. This would mean that their net margins are higher and customers earn low interest rates on deposits, while they pay high interest rates on borrowings.

On a broader note, RBI disappoints as usual in failing to make progress on improving transparency or communication with the market. A two- to four-page concise policy statement that focuses clearly on its challenges, difficulties, options and choices exercised would have been welcome. Instead, we have got a massive 79-page, long-winded report that misses the wood for the trees. Now, even after the credit policy announcement, the market is still left no wiser about what the RBI wishes to do next.