Incremental CRR

• In order to absorb the surge in liquidity in banking system following demonetisation of high value notes, the Reserve Bank of India (RBI) introduced an incremental Cash Reserve Ratio (CRR) of 100 per cent for the fortnight.
• CRR is the amount of deposits banks have to compulsorily park with the RBI without earning any interest.
• Incremental CRR is intended to be a temporary measure within RBI’s liquidity management framework to drain excess liquidity in the system. The regular CRR would however continue to be at four per cent.

Analysis:

• Post the CRR hike, banks will have to park an additional sum of Rs3.24 lakh crore with the RBI without earning any interest. This amount, which is incremental deposits between 16th September and 11 November 2016, would be still paying a minimum of 4% interest to deposit holders. In addition, there is a fear of a penalty being imposed in case banks are not able to deposit the same with the RBI.
• CRR has ceased to be an instrument of monetary control in India since the mid 1990’s, with the CRR being brought down sharply since then. During the early 1990’s additional CRR requirements (in the form of incremental CRR) were introduced from time to time. For example, an incremental CRR of 10% was also levied on various non-resident deposits in order to restrict inflows during such time. Against this background, the imposition of a 100% incremental CRR seems unprecedented and is the first time in history. In fact, the Chakravarty Committee in 1985 had suggested that the incremental CRR should be used only in special circumstances requiring drastic monetary control measures. By this analogy, this imposition is therefore a drastic control measure
• RBI is trying to neutralise two consequences of demonetisation using a blunt tool. One, by raising the CRR to 100% of NDTL, it will drain excess liquidity temporarily and, two, such a giant mop-up will support the 10-year G-sec yield, which fell below the repo rate .
• There were alternative measures available with the RBI, which should have been used. RBI can use cash management bills issued by Government and securities issued under MSS scheme. In particular, cash management bills may have meant better liquidity management since their short tenor would have meant banks having headroom to deal with eventual outflows when the withdrawal limits are unwound.
• According to CRISIL, the immediate impact of this step will cause liquidity to tighten and send bond yields on a northward blip. However, more liquidity is expected to make way into the banking system in the coming days in the aftermath of demonetisation, which will ease the pressure on yields.
• The other impact is on interest rate transmission. Banks could delay cutting their lending rates given that they have promised at least 3-4% interest rate to savings account depositors, but will be not be receiving any interest on the deposits impounded for CRR.

By: Vishal