India’s Central Bank: May the odds be ever in your favor (Part-1)

Right now the bulls are saying “Wake me up when the rate hike ends.”

A poetic yet complete end to the prolonged rate hike hiatus. In May 2020, RBI cut the repo rate by ~40bps in May 2020. In May 2022, RBI shifted its foot from the brake to the accelerator, resulting in a surprise rate hike of 40bps.

Over the next few days, I will simplify the liquidity normalization tools RBI has adopted in an attempt to curb inflation and maintain growth.

Let’s start with the impact of the Cash Reserve Ratio (CRR). RBI has hiked the CRR to 4.5%, a 50bps increase.

The average surplus liquidity in the banking system was at over Rs 7 lakh crore in April, the CRR hike will immediately take out Rs 87000 crores as liquidity and more in 5- 6 months.

What exactly is CRR, and how does a CRR increase affect liquidity withdrawal?

The RBI requires banks to keep a portion of their deposits in cash so that they can be given to customers if necessary. CRR is the percentage of a bank’s total deposit that the RBI requires to be kept as reserves in the form of liquid cash.

So, how does CRR play a role in inflation control? During periods of high inflation, the RBI raises the CRR to reduce the amount of money available for lending by banks. It restricts the flow of money in the economy, reducing investment and lowering inflation.

Stay tuned for the next post on the impact of RBI’s new tool to pump out excess liquidity.