RBI has Reduced Cash Reserve Ratio to 4%, Understand how it will impact Economy

The Reserve Bank of India (RBI) has announced a reduction in the Cash Reserve Ratio (CRR) for all banks by 50 basis points, as per its Statement on Developmental and Regulatory Policies dated December 6, 2024. The reduction will be implemented in two phases: banks will maintain a CRR of 4.25% of their net demand and time liabilities (NDTL) from the reporting fortnight starting December 14, 2024, and further reduce it to 4.00% starting December 28, 2024. This move aims to enhance liquidity in the banking system while supporting economic growth.

The Cash Reserve Ratio (CRR) is a key monetary policy tool used by the Reserve Bank of India (RBI) to control the amount of money circulating in the economy. It refers to the percentage of a commercial bank’s total deposits that it must maintain as reserves with the central bank (RBI). This reserve is not available for lending, investment, or any other use, and the RBI does not pay interest on this amount. The CRR requirement ensures that banks have enough liquidity (cash on hand) to meet the needs of their customers and fulfill short-term obligations.

What Does the Reduction in CRR Mean?

In its latest policy announcement on December 6, 2024, the RBI decided to reduce the CRR by 50 basis points (bps), which is equivalent to 0.50%. This change will occur in two phases:

1. First phase: On December 14, 2024, the CRR will be reduced from its current level of 4.50% to 4.25% of the net demand and time liabilities (NDTL). NDTL includes the total deposits held by banks, which are used as the basis to calculate CRR.
2. Second phase: On December 28, 2024, the CRR will be further reduced to 4.00% of NDTL.

How Does This Impact the Economy?

• Liquidity Boost: By reducing the CRR, the RBI is releasing more funds into the banking system. Banks will now have more money to lend to businesses, consumers, and other sectors of the economy. This increase in liquidity could encourage investment and spending, both of which support economic growth.
• Impact on Lending: With more funds available for lending, banks can provide more loans to individuals (for personal, housing, and vehicle loans) and businesses (for working capital, expansion, etc.). This helps stimulate demand in various sectors of the economy.
• Control Over Inflation: The CRR is one of the tools that the RBI uses to control inflation. By adjusting the CRR, the RBI can influence the supply of money in the economy. A lower CRR increases the money supply, potentially leading to higher inflation if demand in the economy outstrips supply. However, in the current context, the RBI’s decision seems to be aimed at boosting economic activity and addressing any liquidity constraints, given that the economy might be experiencing sluggish growth or lower consumer and business spending.

Why Is the CRR Being Reduced Now?

This reduction in CRR is being made to increase liquidity in the system, likely in response to economic factors such as:

• Slower economic growth: With global and domestic economic challenges, such as geopolitical risks, inflationary pressures, and slow private investment, the RBI may be attempting to stimulate economic activity by ensuring that banks have more money available to lend.
• Inflation concerns: While the CRR reduction can potentially increase inflationary pressures, the RBI likely believes that supporting growth is more critical at this moment. The economy might need a boost, especially if consumption and investment are weak.
• Post-tightening phase: The reduction will restore the CRR to 4.00%, the level it was at before the RBI began tightening its monetary policy in April 2022. This indicates a shift back to supporting economic growth after a period of higher rates and stricter liquidity conditions to control inflation.

Conclusion

The RBI’s decision to reduce the CRR helps inject more money into the banking system, making it easier for banks to lend more, which should stimulate economic activity. The measure comes after a period of policy tightening aimed at controlling inflation, and it signals that the RBI is prioritizing growth and liquidity in the current economic climate. However, the broader impact of this move will depend on how effectively it translates into increased lending, business investment, and consumer spending.