So, where is all money?

It is hard to fault dealers on Mint Street for calling the central bank, the Reverse Bank of India (RBI). Till a few months ago, the RBI was turning off every possible money tap. As there was so much money sloshing around, banks were placing it with the RBI through the reverse repo window. It’s a different story now: the central bank is freeing up liquidity, rolling back bans on capital inflows and assuring money availability. Still, there doesn’t seem to be enough to go around. Banks have borrowed an average of Rs 70,000 crore every day from RBI at 9 per cent for the last three weeks. And yet, the Indian credit markets still seem to have little money—or will—to lend.The cost of a one-year deposit in India has shot up to 10.5-11 per cent from 9 per cent. Banks are coughing up 16 per cent—an 18-month high—to raise overnight money. Public sector banks are unilaterally calling back working capital lines, refusing disbursements on the committed drawdown dates and in some cases even demanding repayments of outstanding dues, disallowing rollovers.
Even large companies, including the stateowned oil giants, are not being spared. “We are seeing an unprecedented situation of liquidity crunch in the global as well as domestic markets,” says D.D. Rathi, Director and CFO at cement and viscose staple fibre giant Grasim Industries.
Credit markets are to economies what oxygencarrying blood is to living bodies. They lend to fund economic expansion and to tide over mismatches between money received and spent by entities, including governments.Cold-shouldered by banks, companies cannot even raise money directly—the market for corporate debt has shrunk. Issuance has less than halved to $40 billion in the first three quarters of 2008 from $88 billion during the corresponding period in 2007. “Money is not available for everyone,” says Rathi. “If it is available, the cost is steep.” The cement giant has been bagging low-cost funds, but the money has all but evaporated for smaller companies. “At this point of time, banks are not willing to entertain any new proposals,” rues the CFO of a midsized Mumbai-based manufacturing company.
So, where did the money go? Liquidity had been tight since the beginning of this fiscal. Then, the forex market cast its shadow on the money markets. Trouble is that the money markets tend to be inter-linked, with movements in one automatically influencing the others. The selling of $10 billion of equity on Dalal Street by foreign investors (they poured more than $17 billion in 2007) since January, servicing of overseas debt by Indian companies and the ballooning oil imports have yanked the rupee down 17.3 per cent against the dollar this fiscal to a five-and-half-year low. To save the rupee from depreciating due to the dollar flight, the RBI has sucked out about Rs 100,000 crore from the system using the Market Stabilisation Scheme over the last two years. The tightening coincides with a high demand for credit, which is growing at the rate of 25 per cent. The central bank has said it wants to slow the rate down to 20 per cent.Money availability worsened in September due to the timing mismatch between government’s revenues and expenditures. By mid-September, the markets were about Rs 70,000 crore short when the news of a series of government-funded bailouts in the US and Europe broke. The RBI’s liquidity-infusing steps and assurances from it and other regulators did little to lift the money markets’ sentiment. Overnight, risk-aversion of banks in India hit a new high. “Banks are borrowing big sums from the RBI daily, but are unwilling to lend it for more than a day,” says Jayesh Mehta, MD, Fixed Income and Client Coverage, DSP Merrill Lynch.SEBI lifted curbs on P-Notes on October 6, and a day later, the finance ministry further eased the external commercial borrowings (ECB) channel for overseas funds.At the last minute, Chidambaram cancelled his meeting with the G7 finance ministers in Washington DC. The RBI Governor, D. Subbarao, too, rushed back to discuss the situation with PM Manmohan Singh. Though the regulators moved in swiftly, decisively and in coordination, the markets continued to remain in panic. “Even if there is money available, nobody wants to take the risk of buying or investing at this point of time.
When the financial system goes through a crisis, it brings down the most unlikely players along with it,” says Sumant Sinha, COO, Suzlon Energy. Grasim’s Rathi adds that while the relaxation of the ECB guidelines was a welcome move, international lenders’ appetite has shrunk drastically and at the same time LIBOR (London interbank offered rate) lending rates have moved up sharply.
The September crunch was not entirely unexpected. It is the quantum of the shortage and the reaction of banks that stunned treasuries and money market dealers. September—just like March—has always been a month of credit shortages in India. It is the month in which companies draw money—over Rs 41,000 crore this year—for paying advance taxes. The Indian liquidity crunch, though, is unlike—and unrelated—to the credit squeeze in the Western markets. Globally, banks are unable to borrow because they have become under-capitalised or they have a huge exposure to bad assets. Banks in India, on the other hand, have recourse to money, even though the cost is considerably up.
The deficit in India then, seems to be of trust, not funds. “These are unprecedented times and the banks are considerably scared,” says Treasury Head, Development Credit Bank, H. Krishnamurthy. “The Asian crisis was localised, but the US subprime crisis has swept the globe.” Are we safe? It is still widely believed that the Indian credit markets are still largely insulated.
Finance Minister P. Chidambaram proclaimed the credentials of Indian banks last week. The lowest capital adequacy ratio for an Indian bank is a little over 10 per cent (considered safe), he assured. Bad assets, too, seem to be under control with gross non-performing assets (NPAs) at 2.11 per cent and net NPAs at a historic low of 0.93 per cent at the end of June 2008. The RBI Governor said in a statement that “the banking system is sound, well-capitalised and well-regulated”. The potential risk comes from any change in the global market conditions that might warrant a shift in the dollar’s strength. That would bring about a reversal in commodity prices internationally. Kotak Mahindra Bank analysts also warn about the “the negatives of the large government borrowing in October.”
Though the sentiment is under siege at the moment, the money squeeze could be short-lived. Kotak Mahindra Bank analysts expect relief soon. “The situation will be alright in November when the government expenditure money will flow back in,” agrees Krishnamurthy. The need of the hour is to see through the volatility and wait to give any direction to monetary policy that might further confuse the market.
The biggest move right now would be for the RBI to restore confidence. After all, banks are not just the safekeepers of money. They also need to make profits, for which they need to lend. But then financial systems are not built on just money but also on trust. It’ll take a while to restore that.