A CRR Cut That Did Not Become Credit

The textbook upper bound. With a reserve ratio r = 4%, the simple deposit multiplier is 1/r = 1/0.04 = 25. Maximum new deposits = 25 × ₹1 lakh crore = ₹25 lakh crore, on an NDTL base of ₹200 lakh crore.

That number should immediately look implausible - it is more than a tenth of the entire deposit base from a single 50-basis-point move. It is an upper bound that assumes zero leakages and that banks were previously reserve-constrained. Neither holds.

Leakages that shrink the realised figure:

1. Currency drain. Deposits grew 10% but currency with the public grew faster, so a larger share of newly created liquidity stopped outside the banking system and never re-entered as a deposit. Every rupee held as cash breaks the chain.
2. Excess reserves. Banks holding government securities well above the statutory minimum are choosing not to convert reserves into loans; they sit as excess reserves or are parked with the central bank. In multiplier terms, the effective reserve ratio is higher than 4%, so the effective multiplier is far below 25.
3. Demand deficiency. Personal loans grow at 18% while manufacturing lending is flat - the constraint is borrowers' willingness to invest, not banks' ability to lend. Weak capacity utilisation means firms do not want project finance.
4. Risk aversion and capital. With infrastructure NPAs near 8%, banks must provision and conserve capital; a CRR cut supplies liquidity, not equity. Undercapitalised banks cannot expand risk-weighted assets regardless of reserves.
5. Import content and repayment. Part of any new loan leaks abroad as imported machinery, and part repays earlier loans rather than financing new spending.

Conclusion: roughly ₹10 lakh crore of credit growth against a theoretical ₹25 lakh crore is not a policy failure - it is the normal gap between a mechanical multiplier and a behavioural one.

Definitions.

• M0 (reserve money / high-powered money) = currency in circulation + bankers' deposits with the central bank (+ other deposits). It is the central bank's liability and the base it can create directly.
• M3 (broad money) = currency with the public + demand deposits + time deposits with the banking system. It is a liability of the banking system plus the public's cash holdings.

The link. M3 = m × M0, where m is the money multiplier (M3/M0). If m falls from 5.2 to 4.8, that is a fall of 4.8/5.2 = 0.923, i.e. −7.7%.

The arithmetic. For M3 to grow 10% while the multiplier fell 7.7%: M0 growth ≈ 1.10 ÷ 0.923 = 1.192, i.e. about 19%. The central bank injected reserves on a scale that more than offset the collapse in the multiplier. This is exactly what a CRR cut plus other liquidity operations would produce.

Why m fell. m is not a policy variable; it is the outcome of three ratios - the currency–deposit ratio (rising, as the public held more cash), the excess reserve ratio (rising, as banks preferred G-secs to loans), and the statutory reserve ratio (falling). The first two moved against policy and swamped the third.

The key judgement. M3 can grow smartly while credit to productive sectors stagnates, because M3 also contains currency and time deposits. Money sitting in a savings account is money supply but is not financing investment. A central bank controls M0 with precision; it influences m only indirectly. Therefore 'money supply grew 10%' is not evidence that monetary transmission worked - you must look at credit composition, not just the aggregate.

Diagnosis first. Evidence points to a transmission and capital problem, not a liquidity problem: reserves are abundant, banks hold excess G-secs, NPAs are high, and manufacturing demand for credit is flat while retail credit is booming. If liquidity were the binding constraint, credit would have responded to a 50 bps CRR cut.

Why 'keep cutting' is a weak prescription:

• Recognition, implementation and impact lags. Six months is short. Repeated pre-emptive cuts risk overshooting before the first cut has worked through.
• The risk-taking channel can misdirect credit. Easier funding in a system with weak capital tends to flow to the segments that look safest or most familiar - here, retail - rather than to the stalled investment segment, which is what actually happened (18% retail versus flat manufacturing).
• Financial stability and inflation. Sustained ultra-easy liquidity against a system with excess reserves risks asset-price build-up in retail lending, and constrains the central bank later if inflation turns.
• Credibility. A central bank that appears to be chasing a single real variable invites expectations that policy will always bail out weak credit, undermining its nominal anchor.

A better package:

1. Recapitalise and clean up bank balance sheets, so that reserves can be intermediated - this is the missing link.
2. Use liquidity tools with better targeting (sector-linked refinance, priority-sector calibration) rather than relying on a single blunt ratio.
3. Fiscal support for demand - public capital expenditure crowds in private projects and creates the borrowers that banks currently lack.
4. Transparency: publish why the CRR cut was expected to work, and what evidence would trigger a pause.

Verdict: cut rates only if the inflation outlook permits, but treat monetary policy as necessary and not sufficient. The commentator's rule confuses a liquidity indicator with a credit outcome.