'The CRR cut signals that the cycle is about to turn'

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Subir Gokarn, Standard and Poor’s Asia Pacific

With the end of the inflationary episode in sight, the Reserve Bank of India (RBI) will in future be free to focus on growth. According to Subir Gokarn, chief economist, Standard and Poor’s Asia Pacific, it is fairly predictable that inflation will come down sharply in March 2009. Given the global financial turbulence and high current inflation, the central bank is maintaining a neutral stance at the moment. It is likely to go in for a cut in the repo rate (the benchmark rate at which the central bank lends funds to banks, and which determines short-term lending rates) either in January, or certainly by April next year, says Gokarn in an interview with Our Correspondent.

What are the primary reasons behind the 50 basis points (bps) cut in the cash reserve ratio (CRR)?
The basic reason is the significant outflow of funds in recent weeks. There was a need to introduce liquidity into the system, and the quickest way to do so was through a CRR cut.

Why is the banking system facing a liquidity crunch? Is it solely because of the outflow of foreign funds or are there other factors at play as well?
The most important factor in the last few weeks is clearly the outflow of foreign funds. In addition, advance tax payments have led to money being sucked out of the system. That money will eventually come back into the system, but there is a mismatch at the moment. Oil companies are still buying forex in the spot market heavily to pay for their imports, because the oil bond arrangement has been suspended. This also adds to the pressure on the currency.
Till recently, you had caps on external commercial borrowings. But now even for companies that normally could have borrowed and brought money in, borrowing has become difficult because of the liquidity constraints abroad. So, a number of factors have contributed to the liquidity crunch.