The Reserve Bank of India today announced a phased withdrawal of the incremental cash reserve ratio it had imposed a month ago, in keeping with Governor Shaktikanta Das’s assertions that the measure was taken as a purely temporary one to impound liquidity resulting from the withdrawal of the ₹2000 notes.

The RBI’s announcement makes it clear that the imposition of the incremental cash reserve ratio was not aimed as a monetary move to control inflation but as a liquidity management tool to deal with the temporary surge in liquidity.

The RBI’s announcements will lend confidence to the markets that the central bank is unlikely to tighten its monetary policy further even though the headline inflation is running well above the upper bound of the 2-6% target band of the Monetary Policy Committee.

CPI inflation was at 7.44% in July, driven by food prices.

Stocks rose and bond yields fell, reacting to the RBI’s announcement that it withdrew the incremental cash reserve ratio.

The central bank is expected to hold its repo rate steady at 6.5% in the coming months and manage liquidity in future with market instruments such as the variable rate reverse repos.

The RBI’s primary liquidity management tool is the 14-day variable rate reverse repo auction. It will also conduct shorter-tenor variable rate reverse repo auctions as a “fine-tuning” operation.

TEMPORARY MOVE

In a statement accompanying the August MPC resolution, the RBI said effective from Aug 12, it was imposing an incremental cash reserve ratio of 10% on deposits that accrued between May 19 and July 28.

This move was going to impound over ₹1 trillion of banks’ liquidity.

The RBI had said this measure was intended to absorb the surplus liquidity generated, in particular, by the return of ₹2000 notes to the banking system.

Governor Das also said he intends to return the liquidity to the banking system before the festival season. The festival season begins this month with the Ganesh Chaturthi celebrations and will continue till Christmas.

The RBI hopes that currency leakage from the banking system—with people withdrawing money to spend during festivals—will keep the liquidity overhang in check and ensure liquidity does not add to inflationary pressure.

Today, the RBI said it was releasing the impounded liquidity in stages.

It said 25% of I-CRR maintained will be released on Saturday, Sep 9. Another 25% of the impounded funds will be released on Sep 23.

The balance 50% of the impounded funds will be released on October 7, a day after the RBI’s October MPC meeting.

Release of the impounded funds would mean that banks would not have to clamor for deposits. This move could halt a rise in banks’ deposits as well as lending rates.

POLICY IMPLICATIONS

The RBI said today that it was releasing the money impounded by the I-CRR in stages and not in one shot (it drained liquidity in one shot with this measure last month) because it did not want to subject the money markets to sudden shocks.

The RBI said it wanted to return the liquidity in an orderly fashion.

Liquidity is set to tighten from next week because businesses will pay their quarterly advance tax by Sep 15. The release of impounded funds on Sep 9 and on Sep 23 will ensure that money market rates do not shoot up.

However, from a broader policy perspective, the RBI’s reversal of incremental CRR indicates that the central bank is not looking at fresh monetary measures to bring down inflation within its mandated target range of 4-6%.

Das said recently that the spurt in inflation in July was caused by the prices of tomatoes. He had said the prices of “TOP” – tomatoes, onions, and potatoes - misbehave from time to time. He warned that inflation for August—data will be released next week—will also be very high.

Das said the drop in tomato prices and recent supply-side measures taken by the government, which include a ban on the export of rice, cuts in prices of LPG and imports of certain food items, will bring down inflation.

The RBI’s measure today suggests that it is seeing through the impact of food prices on inflation and no further monetary tightening is likely.