If the element of surprise is a critical aspect of central banking, then the Reserve Bank of India deserves full marks for employing it to good effect on Friday. Bankers, economists and analysts alike were caught by surprise with both the timing and the quantum of the cut in the cash reserve ratio (CRR) announced today [Friday].

More liquidity

While the widespread feeling was that the RBI needed to free up more liquidity, the general expectation was that it would be done in the mid-quarter review due on March 15. Similarly, the market anticipated a 0.50 percentage point cut but the central bank surprised on the upside with a cut of 0.75 percentage points.

The cut was prompted by the rather tight liquidity conditions that prevailed in the last few weeks leading to a firming up of short-term interest rates. Bank borrowings under the liquidity adjustment facility with the RBI peaked at Rs.1,91,700 crore on March 1 though it declined by the middle of this week to Rs.1,27,300 crore.

Pre-emptive step

With the deadline for the final instalment of advance tax payments coming up on March 15, banks would have been stretched with companies borrowing to pay their taxes. The CRR cut is, therefore, a pre-emptive step to boost liquidity ahead of peak demand period.

The cut should, therefore, be seen for exactly what it is: a step to release more funds into the system. It would be a mistake to view this as a monetary policy signal; that privilege belongs to the mid-quarter review alone. That said, bankers' appetites have been whetted with the latest central bank action and most of them are waiting in anticipation of a repo rate cut, come March 15.

However, with oil prices remaining high and the government weighing the option of increasing retail fuel prices, it is difficult to foresee a rate cut next week. But who knows what the RBI will do.

The central bank surprised us today [Friday], it may surprise us yet again in a week's time.

More In: Economy | Business