The Reserve Bank of India has raised concerns over potential asset price bubbles stemming from excess liquidity in the banking system, owing to weakening lending standards. These concerns were shared in context with the recent measure to mandate banks to maintain a cash reserve ratio (CRR) on their incremental deposits.
In the August review of the monetary policy, the Reserve Bank of India required scheduled banks to maintain an additional 10 per cent CRR on the increase in their net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023. This incremental CRR (I-CRR) mandate took effect from August 12, and the temporary decision will be reviewed on or before September 8.
The report commented that recent developments, such as the return of Rs 2000 banknotes primarily through deposits, have expanded liquidity disproportionately. This situation has caused dissonance with the disinflationary stance of monetary policy and hindered the transmission of policy impulses across the interest rate spectrum.
“The slosh of liquidity also has implications for financial stability in the form of potential asset price bubbles and weakening of lending standards,” the report warned.
It further stressed the necessity of temporarily pre-empting surplus liquidity from finding loopholes, as the banking system works on absorbing the excess into prudent credit expansion. This report, authored by RBI staffers, including deputy governor M.D. Patra, does not necessarily reflect the central bank’s view.
Simultaneously, the report noted that the I-CRR decision would confine some of the surplus while maintaining adequate liquidity for regular banking operations.
The intention behind the I-CRR mandate, labelled as temporary, is to return the sequestered funds in anticipation of advance tax outflows from the banking system and well ahead of the typical increase in demand for bank credit in the second half of the year.
Amid Consumer Price Index (CPI) inflation reaching a 25-month high in July due to the economy’s vulnerability to sudden vegetable price shocks, the report urged for ‘major reforms’ in perishable supply chains. This includes improvements in transportation networks, warehousing and storage technologies, and processes that reduce drastic price fluctuations.
“The uptick in inflation in its June reading mutated in July, with the unprecedented shock to tomato prices affecting other vegetables,” the report observed.
While acknowledging that core inflation softened in July, the report cautioned that the wave of supply shocks was not over, with elevated vegetable prices persisting into the first half of August. Consequently, headline inflation is expected to average well above 6 per cent in the next quarter, aligning with the August monetary policy review’s projection of 6.2 per cent inflation for the July-September period.
Additionally, the report revealed that high-frequency food price data up to August 14 shows a continued increase in cereals and pulses prices, while edible oil prices declined. Tomato prices registered further increases in August, with sequential upticks in onion and potato prices.
“It is noteworthy that despite the sharp pick-up in inflation, the risk of stagflation remains low at the current juncture,” the report concluded, offering a measured reassurance against a concerning economic scenario.