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RBI May go for CRR Cut Vs Interest Rates

October 30, 2012

The Finance Minister thinks he has done enough for the RBI to go ahead with the Rate Cuts. However, we think not as Inflation Data reflects that Government is still under crisis and is just managing the Press / Media phenomenally well.

RBI Gov Subbarao will likely not want to take to take chances with the RBI’s inflation fighting image by cutting rates as inflation will persist at a high 7.5-8% till December. CRR cuts, to begin with, are more impactful in the Indian case as the relationship between money, output and Inflation is still high yet stable there. RBI’s repo rate cuts are not as powerful as other central banks’ as banks park 80% of their gilts.

What is the Likely Action of the Governor Today ?
Analysts expect the RBI to respond to Delhi’s reforms after a a gap of 3 years with more than 25bp CRR cut, last time in Sept-2012. We are thus expecting a 50bp CRR cut to pull down lending rates by 25bp.

Impact of CRR Cut
CRR cuts soften lending rates by (1) reducing the cost of deposits and (2) releasing additional resources to banks to lend. At the same time, CRR cuts cannot suffice by themselves as they often take at least 6 months to work. Various studies point out to a 50bp cut in CRR directly impacts banks’ earnings by about 2.5%

What about the Lending Rates ?
The RBI’s rate actions do not, in themselves, have a sufficient compelling impact on bank balance sheets to move lending rates. At the end of the day, a 25bp repo rate cut will release a mere Rs1.8bn (US$300mn) to banks. RBI rate cuts will not necessarily transmit to lending rate cuts unless bank liquidity improves.

Let us wait for a couple of hours for the RBI Governor to air his Team’s views on the Indian Economy.

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