CRR cut a balancing cut, will fix liquidity issue: Experts

The Reserve Bank of India, on January 24, has brought down the cash reserve ratio (CRR) by half a percent to 5.5%. CNBC-TV18's special show Indianomics economists discuss if CRR was the right tool for the RBI to use now, when manufacturing inflation is still rising, and at a rising pace.

Guests in the show include Shankar Acharya, Director at ICRIER and Samiran Chakrabarty, Chief Economist and Head of Research at Standard Chartered Bank talk about the issue with CNBC-TV18's Latha Venkatesh.

Here is an edited transcript of their comments. Also watch the accompanying videos.

Q: Up until December, core inflation is still rising at a rising pace. At this juncture should the RBI have cut CRR, especially because of the liquidity ramifications it has?

Acharya: I think so, it's a very nuanced policy statement that RBI has given which has essentially very clearly tried to communicate the concerns across a range of fronts. First of all they are now showing a significant concern or worry about the growth slowdown and so that has to be an important factor.

Secondly they recognise that as they put it in the rate of inflation in non-manufactured food products and protein items amongst food products. There the rate of inflation on a YoY basis is still higher than the comfort zone. It is only in vegetables really that you have had this substantial drop in the YoY rate.

So, I think they are very conscious of all these factors, but I think they are doing a weighing of growth inflation in my view in the right way and the right spirit. I think that, that is why the other factor to be brought in is ofcourse that as everybody knows the degree of tightness in liquidity at the short end has been very steep and high for quite a while.

As you know the amount of injection from the RBI at the repo rate has been running above Rs 1 lakh crore for some time now and that's above the comfort level of the RBI which is I think 1% of the net demand deposits. So, taking all this into account what they have done is, if you notice that they have done a significant cut in the CRR.

This still will require further management of liquidity through the existing instruments of both open market operations (OMO) as well as accommodation through the liquidity adjustment facility (LAF). So, it is not as if those are being substituted for in a whole sale manner. So, its just that its giving us a signal that we are going to do some loosening of monetary policy which is in part targeted towards the short end liquidity tightness So, it's a very nice balance. They have not touched the repo rate at this stage though some people including myself might have wanted some little tingle there.

Q: We have a fisc that has been fueling aggregate demand pretty happily. With this kind of a looseness, little bit of monetary fuel, liquidity fuel getting injected into the market which will multiply as the months go by, is this a safe thing to do at all for the RBI at this juncture?

Chakrabarty: I completely agree to your fear of inflation coming back in the later half of the year. There are enough reasons to be afraid of inflation that I completely agree. But where I think I have a slightly different view is that large part of the inflation both whatever we have seen and we are likely to see, they are not really the classical version of inflation which has been fueled by excess money supply.

For a large period of time our money supply growth has remained relatively stable. A very crude way of looking at it is that money supply growth has been lower than nominal GDP growth, for most of the this period, showing essentially that it is not a liquidity driven inflation.

So, in that sense in this particular quarter, in all likelihood nominal growth might have actually slipped below money supply growth and there was a little bit of a need for liquidity calibration. From that perspective I think the CRR was the right move to take.

Whatever said and done if RBI was not doing CRR and doing OMO then the same money multiplier would have worked on the OMO itself because OMO also would have expanded base money and had an impact on money supply.

From that perspective we cannot differentiate between a CRR and a OMO. Where the differentiation can come is CRR is kind of free money for the banks, whereas OMO has a cost attached to it, but on the other hand if you do too much of OMO you will always be criticized that you are funding your fiscal deficit and lets not forget that at least in this policy statement RBI has been very clear about fiscal consolidation.

So, on one hand you cannot suggest fiscal consolidation and do a lot of OMO to support a high fiscal deficit. There is a kind of difficult situation to do too much of OMO. So, from these two angles I think I would support the CRR cut, as I have said in this show before that I have strongly advocated for a CRR cut even before the policy.

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