CRR slicing will help reduce lending rates

Okay, no rate cuts but just a 25 basis points (bps) cut in cash reserve ratio (CRR) to 4.50% of deposits. From here on, the Reserve Bank of India (RBI) is likely to continue treading carefully on monetary easing, particularly as the third tranche of quantitative easing or QE3 in the US can drive up global commodity prices, especially crude oil, and therefore local inflation.

The central bank would rather wait and watch the impact of QE3 in the US and the foreign direct investment (FDI)  measures in India on three things: investment activity, inflows of capital into India and rupee value.

If capital inflows pick up and the rupee appreciates sharply from here on, the RBI would be more comfortable in cutting rates.

That said, the probability of a 25 bps cut in the repo rate in the October policy meeting has increased in order to support growth.

The RBI has now used all the liquidity infusion tools at its disposal to ease monetary conditions.  Therefore, the next move will most likely be on the rates side, where the RBI does have some room to effect a 50 bps cut in repo rate.

While welcoming the September 13-14 reforms, the RBI has maintained that given the persistent inflationary pressures alongside the emerging risks from post-QE3 liquidity boost, the focus of monetary policy will remain on managing inflation and inflationary pressures.

The RBI also added that the steps taken by the government were anticipated and were taken into account in April when the repo rate was cut by 50 bps.

In terms of macroeconomic policy response to slowing growth and inflation (which is firming up in spite of slowing growth), the RBI has remained on the side of curbing inflation, recognising the limited tools at its disposal. The role of non-monetary factors and supply-side constraints in slowing growth, and the need to maintain a low-and-stable inflation, are imperative for attaining higher sustainable growth.

In fact, even the CRR has been cut in anticipation of liquidity tightness in the second half of the year on account of a seasonal pick-up in credit offtake.

The CRR cut will help reduce lending rates in the banking system which, in turn, would help boost economic activity, especially leveraged consumer demand.

Kapur is senior economist at the Royal Bank of Scotland NV. Views are personal