Monetary Policy: Has Raghuram Rajan Just Announced India’s QE-1?

Has Raghuram Rajan just launched a cautious Indian version of QE-1 – the first phase of quantitative easing that will flood the money markets with liquidity over this financial year?

In his first bimonthly monetary policy statement for 2016-17 today (5 April), he announced that the Reserve Bank of India (RBI) will steadily reduce the systemic liquidity deficit of over Rs 1.5 lakh crore by buying back assets from banks and institutions. This means that he will be liberal with his open market operations (OMO). In round one, he has already announced OMOs of Rs 15,000 crore today.

When the US Federal Reserve launched its various QEs, it bought back bank assets to pump more liquidity into the system and push credit growth. Rajan is doing the same, but more cautiously.

Rajan said it had been “decided to i) smooth the supply of durable liquidity over the year using asset purchases and sales as needed; ii) progressively lower the average ex-ante liquidity deficit in the system to a position closer to neutrality.” This means over 2016-17, the RBI will reduce the current Rs 1.5 lakh crore daily liquidity deficit to zero. Hence this could be termed a cautious form of QE.

Formally, the Reserve Bank has cut repo rates by 0.25 percent to 6.5 percent. The repo rate is the rate at which the central bank lends short-term money to banks. But this is not the news, for it has been widely discounted. The big deal is what Rajan has done on easing liquidity. He has signalled easy liquidity and a flood of cheap money to banks that will go a long way in easing interest rates in the economy; banks will surely part with some of this largesse with borrowers.

Rajan did not cut cash reserve ratio (CRR), the biggest non-performing asset of banks that fetches them no interest, but has eased the rules for maintaining daily CRR. Now, instead of maintaining a minimum of 95 percent of the required CRR daily, banks can maintain an average of just 90 percent of their required CRR levels daily. This means banks will have more free cash on many days during the CRR reporting fortnight.

Even better, the RBI has narrowed the gap between the repo and reverse repo rates from 1 percent to 0.5 percent, which means the reverse repo is now at 6 percent, up from the 5.75 percent before this policy. Now, if banks fall short of CRR, they will get to borrow cheap, but if they have excess funds, they will get to keep the surplus with the RBI at a higher rate through the raise in reverse repo.

In doing this, Rajan has effectively made it easier for banks to earn more, even while allowing them to lend more to borrowers at cheaper rates. Since the beginning of the monetary policy easing cycle, the Reserve Bank has cut repo rates by 150 basis points (1.5 percent). Not much of this cut has been passed on to borrowers, as banks have seen a deterioration in their portfolio of bad loans, which has brought many of them higher losses. In the December 2015 quarter, public sector banks reported over Rs 11,000 crore of losses.

To improve liquidity, Rajan also promised to talk to Arun Jaitley so that he can reduce the surplus cash balances with the Reserve Bank. One reason for the tight liquidity has been the tendency of the government to keep higher idle balances with the central bank instead of spending it. When governments save more than they spend at any point of time, it tightens liquidity.

But with the fiscal deficit target for 2015-16 possibly achieved, Arun Jaitley is sure to reopen the spending tap to boost growth.

Rajan’s QE-1 will help.