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RBI Policy: Inflation High, CRR Cut Unlikely


Two things are expected of the RBI today, in their monetary policy statement. One, that it will not raise interest rates – a stance taken already in end November in their mid quarter review – or actually cut rates. Second, that it will effect a cut on the Cash Reserve Ratio (CRR) from the current 6%.

Given the Macroeconomic statement yesterday, it doesn’t seem like both are likely.

on Inflation:

While growth outlook weakens, inflation risks remain

  • The Growth outlook has weakened as a result of adverse global and domestic factors. However, inflation and expectations of inflation remain high and upside risks emanate from exchange rate pass-through, revisions in administered prices and higher-than-expected government revenue spending. Consequently, monetary actions will need to strike a balance between risks to growth and inflation.

  • Growth in 2011-12 is moderating more than was expected earlier. The business climate has weakened. The slack in investment and net external demand may keep the pace of recovery slow in 2012-13.

  • While in the short run, moderating inflation will provide some space for monetary policy to address growth concerns, in the absence of structural measures to address supply bottlenecks, this will be, at best, a temporary respite. In addition, the expansionary fiscal stance has emerged as an upside risk to inflation.

And later

Inflation is trending down, but upside risks remains significant

  • Inflation is moderating led by sharp decline in food inflation and is broadly in line with the 7 per cent projection for March 2012.

  • Primary food inflation declined sharply reflecting seasonal fall in vegetable prices and high base. However, as protein inflation continues due to structural demand-supply imbalances, the decline is expected to be short-lived.

  • Inflation in non-food manufactured products remains persistently high, reflecting input cost pressures, partly resulting from the rupee depreciation that has offset the impact of softer global prices of some commodities.

  • Upside risks to inflation persist from insufficient supply responses, exchange rate pass-through, suppressed inflation and an expansionary fiscal stance.

When you hear language like this you don’t think “repo rate cut”. You think, “wait and watch”. The language for repo rate cut is – “Growth has moderated significantly while inflation risks are benign”.

On Liquidity – that it is too tight will mean that they will cut CRR:

Monetary growth keeps pace even as money market liquidity tightens

  • Money market liquidity tightened   significantly   since   November 2011 partly due to dollar sales by RBI. However, monetary growth has kept pace with projections, on account of a rising money multiplier. The liquidity stress was handled by the Reserve Bank by injecting liquidity through open market operations, including repos under the LAF.

  • Credit growth slowed below the indicative projection due to demand as well as supply side factors. Demand for credit weakened in response to slack in real   activity. Supply also slowed down with rising risk aversion stemming from deteriorating macroeconomic conditions and rising non-performing loans.

(Emphasis mine)

What they mean is that liquidity is tight not just due to the economic tightening but due to the selling of the dollar by the RBI (which takes rupees out of the system). We don’t know the extent of that selling yet. Therefore, the OMO auctions – where the RBI pays rupees and buys government bonds – is essentially replacing that lost liquidity, and until they fully replace it RBI won’t really know how bad the situation really is on the liquidity front.

Overall, the CRR cut may not happen (such things are never temporary) until the RBI is reasonably sure that the liquidity issue is beyond what the RBI is doing by intervening in the forex market.

I may be wrong. We’ll know in 15 minutes.


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