CRR should be reduced: C Rangarajan

The Prime Minister’s Economic Advisory Council Chairman, C Rangarajan, has opined to reduce the use of CRR and suggested that it should be used only in extraordinary circumstances. As per him, the need for using it reduces with the option of Open Market Operations (OMOs) already in place.

• Cash Reserve Ratio which is abbreviated as CRR is that minimum part of deposits that a commercial bank has to keep with the central bank. It is used by the central bank in monetary policy. Before 1991 financial reforms, CRR and SLR (Statutory Liquidity Ratio) was also a major instrument to source of funding and control over credit and interest rates. But after the reforms, the use of CRR as an effective instrument was de-emphasized and the use of Open Market Operations came to the fore. OMO’s are more effective in adjusting market liquidity.

What is Open Market Operation (OMO)?

• OMO is an activity by a central bank to buy or sell government bonds on the open market. A central bank uses them as the primary means of implementing monetary policy. The central aim of OMO is to control the short term interest rate and the supply of base money in an economy, and thus indirectly control the total money supply. This involves meeting the demand of base money at the target interest rate by buying and selling government securities, or other financial instruments. Monetary targets, such as inflation, interest rates, or exchange rates, are used to guide this implementation.

Types of OMO are used by RBI:

1. Outright purchase (PEMO): Is outright buying or selling of government securities. (Permanent)

2. Repurchase agreement (REPO): Is short term, and are subject to repurchase.

As per the prescription by PMEAC:

• If government is not able to capitalize public sector banks timely under Basel-III norms, their market share will decline
• The govt has to make additional budgetary support in order to meet about 50% of additional capital requirement
• Low base effect in the second half of last year will help gross domestic product to show higher growth by end of this financial year
• Growth rate will regain pace, it probably will touch 8% in next 2 years

Month: Current Affairs - September, 2012