RBI could extend incremental CRR to rein in liquidity

economictimes.indiatimes.com:

Reserve Bank of India (RBI) may extend the temporary incremental cash reserve ratio (CRR) it imposed on banks last week as the monetary authority is seen training its sights on liquidity management to tackle inflation rather than lifting benchmark policy rates to tame wild jumps in food prices. Consumer Price Index (CPI) inflation surged to 7.44% year-on-year in July from 4.87% in the previous month, driven primarily by high vegetable prices.

The RBI’s target for CPI inflation is 4%, while its tolerance band is 2-6%. The RBI may not increase the repo rate as it ascertains the durability of high food prices while seeing the impact of previous rate hikes work their way through the economy, which faces threats from a weak external environment.

The central bank can, however, bolster transmission of its policy actions and prevent borrowing costs from turning cheaper by keeping a tight leash on banking system liquidity. “In the near term we expect RBI will maintain its focus on liquidity management to ensure liquidity remains close to neutral and the interbank weighted average call rate remains at or a tad above the repo rate.

As such we see a high probability that RBI may continue with the incremental CRR announced on August 10, which is expected to be reviewed on September 8,” said Upasana Chachra and Bani Gambhir, economists at Morgan Stanley. Surplus liquidity in the banking system has risen sharply over the past couple of months due to the return of Rs 2,000 notes to banks, a higher-than-budgeted surplus transfer from the RBI to the government and overseas inflows.

In August, the daily average amount of surplus funds parked by banks with the RBI was at a 14-month high of Rs 2.5 lakh crore. Surplus banking system liquidity