India's central bank on Friday cut the cash reserve ratio (CRR) requirement for banks sooner and more sharply than expected to ease tight liquidity, an accommodative move seen by some as raising the odds for an interest rate cut next week. The Reserve Bank of India cut the cash reserve ratio, the share of deposits that banks must hold with it, by 75 basis points to 4.75 percent after the close of local markets.
The sharp and accelerated CRR cut upset conventional market wisdom that the RBI's mid-quarter policy review scheduled for March 15 would see a 50 basis point CRR cut and no lowering of policy interest rates. "The fact that they did a CRR cut 4-5 days before the policy and one day after the (RBI) governor met the finance minister raises doubt on the question that there will be no rate cuts in March policy," said Hitendra Dave, head of global markets at HSBC India.
At the same time, a CRR cut is no longer seen as a possibility at next week's review, economists and traders said. The central bank is widely expected to begin cutting interest rates in coming months after 13 increases between March 2010 and October 2011, as both economic growth and inflation slow. However, few in the market had expected it to do so as soon as next week.
India's annual economic growth slowed to 6.1 percent in the December quarter, its slowest pace in nearly three years. Headline inflation, meanwhile, slowed to its lowest level in more than two years in January. One senior dealer at a foreign bank in India said Friday's CRR move changed his expectation on rates.
"A 50 basis point CRR cut would have taken care of the liquidity problem. But since they did more than that it means that RBI's stance is changing and so rate cuts can be expected next week," said the dealer, who declined to be identified because he is not authorised to speak to the media.
The cut will inject about 480 billion rupees ($9.63 billion) of liquidity into the banking system, which the RBI said had been on track for a worsening deficit in the second week of March, partly because of scheduled outflows for payment of advance taxes by companies.
"It has been decided to inject permanent primary liquidity into the system by reducing the CRR so as to ensure smooth flow of credit to productive sectors of the economy," the RBI said in a statement. The move is expected to result in a steepening of the swap yield curve, with short-end rates falling more than the long-end, while the 10-year government bond yield is expected to soften by 2-3 basis points.
Stocks may also get a lift. "The quantum of the cut has definitely come as a surprise. So to that extent the move will impact the markets positively, especially banks," said Srividya Rajesh, fund manager at Sundaram BNP Paribas Asset Management in Chennai. Rajesh does not expect an interest rate cut next week. "We are still some time away from the interest rate cut because the crude price is high and the rupee has again depreciated a bit," she said. The market has been wrong-footed in recent months in its expectations from the central bank on the CRR.
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