Economic Crisis: Injecting liquidity, proactively

As we have been observing the past few weeks, the RBI has been making swift moves to arrest the prevailing global financial crisis from making any deep inroads into our financial system.
The RBI Governor has clearly indicated that the monetary measures initiated recently were proactive to address the pressing requirements arising out of events occurring outside the country. The proactive measures of the RBI — the cut in CRR in quick succession by 250 basis point and the reduction of 100 basis point in the repo rate have certainly injected liquidity amount of Rs 1 lakh crore into the system.
In the first week of October, the call rate moved from 16.75 per cent to 21 per cent and after the cut in CRR, it came down to 6 per cent. At the same time, the inflation rate also came down to 11.07 per cent on October 23 from 12.40 per cent on August 28. Multiplier effect
Rightly, therefore, the RBI has not touched upon these tools in the Mid-Term Review of the Annual Policy announced yesterday. The multiplier effect of the recent measures towards easing the liquidity is yet to be seen.
Foreign institutional investors have seen the value of their India portfolio drop three-fourths or about $190 billion this year, a tumultuous one for the market worldwide. FII holdings dropped to below $60 billion this week, from around $ 244 billion in January. Correspondingly, India’s forex reserves dropped from $315 billion to $274 billion in October.Inflation, key concern
The Governor’s main concern remains inflation control as he has decided not to reduce any key rates, quite contrary to market expectations. In short, the review policy is directed more towards stability, inflation control and achievement of reasonable growth. One has to appreciate that the central bank has remained proactive and has been taking steps to restore confidence to the investors and the market. It has been a roller-coaster ride. Inflation which was seen as a major issue in the previous policy of July 2008 mainly on cost-push and demand-push factors is no more a bother, thanks to more than 50 per cent reversal in domestic and global commodity prices and lack of demand on recessionary trends arising from the global financial crisis. Shift in concerns
The focus has now shifted to addressing growth and liquidity concerns.
Although the RBI reversed its earlier CRR and repo rate hikes from a peak level of 9 per cent to 6.5 per cent and 8 per cent respectively, there are no clear signs of restoration of normalcy.
The main issues that were presumably engaging the RBI ahead of the policy were restoration of credit confidence in the system due to lack of availability of funds at affordable cost and counter balancing the liquidity sapping impact of dollar sales to cushion the falling rupee.
The expectation from the market was not only to provide adequate liquidity through more cuts in the CRR and/or key reference rates but to provide sector-specific support mainly to export-oriented units, small-scale industries, small and medium enterprises, stock market investors and traders.
The adequacy of liquidity is now largely dependent on the extent of RBI’s intervention in the foreign exchange market (wherein rupee posted a new low of 50.15 in the morning trades, ahead of the policy) while there is a genuine need for reduction in reference rates to cool down the deposit and lending rates. There is also need to get an effective solution to arrest the rupee fall (through tapping NRI resources) as recent measures of relaxation in ECB norms and token increase in NRI rates have not yielded desired results.
Needy sectors As a support to needy sectors to de-risk credit default crisis in the financial system, there may be a case to direct fund flows to SSI/SME units through SIDBI, agricultural-oriented units through Nabard and foreign currency funding to import/export-oriented units through EXIM Bank through special refinance schemes for banks. To arrest the fall in the stock market, the RBI could also have been expected to revise upwards the capital market exposure of banks and review downwards the capital risk weight from the current level of 150 per cent.
While leaving CRR/SLR rates unchanged given the comfortable liquidity in the system is understandable, the main issue on dollar-rupee exchange rate, which is draining the liquidity from the system, requires to be dealt with. The RBI’s aggressive intervention in the foreign exchange market has already removed most of the liquidity provided to the system.
If liquidity remains tight in the coming days, then the RBI might look at cutting CRR and/or SLR rates.Call rates ruling in the 6-8 per cent corridor would have guided the RBI to keep key rates unchanged, but possible liquidity pressure in the new fortnight starting October 25 with call rates expected to trade above the repo rate, might guide a cut in key interest rates into the 5.5-7.5 per cent corridor. So, it appears that RBI has considered adequacy of the liquidity and its cost at current level as satisfactory and would be prepared to act when warranted.Overall, of course, we have no doubt that the RBI will act decisively when warranted and it is not necessary that these measures need to be announced on the policy day.