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September 17, 2012

RBI Cuts CRR to 4.5 Percent and Keeps Repo Rate Unchanged

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The Resrve Bank of India today (17th Spetember 2012 - Monday) cut the cash reserve ratio from 4.75 per cent to 4.5 per cent. The central bank took the government’s reforms rendition a note higher by cutting its key cash reserve ratio by 0.25 per cent to increase liquidity flow into the economy. It kept the short term lending and borrowing rates unchanged. The cut in the Cash Reserve Ratio will release Rs 17,000 crore (Rs 170 billion) into the financial system.
The central bank left Repo Rate, the effective policy rate, unchanged at 8 per cent. Reverse Repo Rate was also untouched and remains constant at 7 per cent.

The CRR stipulates the minimum proportion of deposits that banks must hold with the central bank. When the RBI increases the CRR, banks have fewer funds to lend or invest since they have to park more money with the RBI.

Repo rate is the rate the central bank charges to lend to banks against securities.  If banks have to pay more to borrow money, they may increase the rates they charge their customers or may borrow less, thus reducing inflation.

After the government announced a hike in the price of diesel and followed it up with some big-ticket reforms late last week, India Inc. has been clamoring for a rate cut from the central bank. Amid slowing growth and downgrades from global investment banks—some even threatening a downgrade to junk status—the RBI has steadfastly said controlling inflation is its key priority.

"Controlling inflation is the top most priority of the central bank," Chakrabarty told students of a city college in New Delhi on Friday, 14 September 2012, when inflation numbers for August were released by the government. After falling a bit in the previous month, inflation rose to 7.55 per cent in August, driven by higher prices of potatoes, wheat and pulses which rose due to poor monsoons.

The spike in August's Wholesale Price Index was also driven by a rise in the prices of manufactured items, further whittling down the efforts of the monetary authority to batten down inflation.

Mr Chakrabarty admitted that the nearly two-year-old rate hikes to combat inflation have had an impact on growth, driven by slowing investments. "We agree that investment has slowed down due to higher interest rate." In its previous policy review end-July, the RBI left interest rates unchanged for the second time since June, in line with expectations, while cutting its growth forecast and lifting its inflation outlook as economic conditions deteriorated.

However, it cut the statutory liquidity ratio (SLR, the amount that commercial banks have to maintain in liquid assets, such as gold or cash) to 23 per cent from 24 per cent, effective August 11. "In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth," RBI governor D. Subbarao wrote in the previous monetary policy review, adding the central bank's primary focus remains inflation control.

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