The 25 basis points cut in CRR would infuse Rs17,000 in to financial systems, thus allowing banks to reduce interest rates on loans to attract borrowers

The Reserve Bank of India (RBI), in its mid-term monetary policy review has cut cash reserve ratio (CRR, the amount of deposits banks keep with the central bank) by 25 basis points (bps) or 0.25% to 4.5%. The central bank, however, kept other policy rates like repo rate, reverse repo rate and bank rate unchanged at 8%, 7% and 9%, respectively.

The cut in CRR is expected to release Rs17,000 crore into financial systems. With additional liquidity by CRR cut, there is a possibility that banks may reduce the interest rate to attract borrowers.

"Since the first quarter review (FQR) in July, while growth risks have increased, inflation risks remain. In the current situation, persistent inflationary pressures alongside risks emerging from twin deficits - current account deficit and fiscal deficit - constrain a stronger response of monetary policy to growth risks," RBI governor D Subbarao said in a statement.

The wholesale price-based inflation for August moved up to 7.55% from 6.87% in the previous month.

Dhananjay Sinha, Co-head for research, Economist and Strategist at Emkay Global Financial Services, said, "RBI still sounds fairly hawkish despite appreciating the recent measures taken by the government on FDI, fiscal consolidation (efforts to reduce fuel subsidies) and pro-activeness shown on PSU disinvestments. RBI believes that inflation momentum remains fairly strong and it would want to wait for these measures to sustain and translate into productivity gains before unequivocally favouring monetary easing."

Ironically, the flurry of events last week with diesel price hike and the third round of monetary easing have only compounded problems for Subbarao, who has been both blamed and credited in equal measure for his inflation phobia over the past 30 months or so.

Already the US and ECB actions had their immediate impacts on inflation as the commodity prices rose instantly across the globe. Gold hit a new high, metals are on a song and the most crucial crude rose nearly 1.5% post the Fed announcement to buy $40 billion of US government bonds every month till the end of 2015.

After an unprecedented easing that began with the 2008 credit crisis, the RBI embarked on a rate hike spree beginning October 2010 which lasted till December 2011, during which Subbarao jacked up the repo rate by a whopping 425 bps to 8.50% through 13 consecutive rate hikes.

But expecting the government to do its bit, as growth began to nosedive; he reduced CRR by 50 bps in this January and again by another 75 bps in March to pump liquidity into the system. Again, in April annual policy he did the unexpected by a 50 bps cut in the repo rate.

But to his disappointment, the government looked the other way and did nothing on the fiscal and supply-side front.

But since last Thursday, all that is past as the government has really moved onto top gear with an avalanche of measures to boost both investment and sentiment.

Following are the highlights of the RBI's mid-quarter monetary policy review...

1. Cash Reserve Ratio or CRR cut by 0.25% at 4.5%
2. Repo and reverse repo rates kept unchanged at 8% and 7%, respectively
3. CRR cut to inject Rs17,000 crore into banking system
4. Government's recent reform initiatives to result in favourable growth-inflation dynamics
5. Inflation remains a challenge; growth risks have increased
6. Diesel price hike, subsidised LPG cap to put pressure on inflation
7. Economic activity in July-September quarter to remain subdued
8. Sustainable current account deficit to depend on fiscal consolidation