RBI Desperate measures

The central bank on Saturday unexpectedly cut its repo rate or main short-term lending rate by 50 basis points to 7.5% and banks' cash reserve requirements by 100 basis points to 5.5%.It also cut banks' bond reserve requirements by 1 percentage point to 24% of their deposits with effect from November 8, 2008, the central bank said in a notification posted on its website.

The cut in its repo rate will take effect from November 3. The cut in banks' cash reserve requirements will take effect in two steps -- one from the fortnight beginning October 25 and the second takes effect from November 8 and will release Rs 40,000 crore into the banking system.

The move follows a 100 basis point cut in its main short-term lending rate last week and is the latest in a slew taken by policymakers to combat the spillover effects of a global financial crisis.
But given the present dynamic situation, it may be left with little choice but to do so. On Wednesday, banks borrowed Rs 56,095 crore worth of overnight money from the RBI, even as the inter-bank interest rate on such funds again shot up to around 12%.

RBI is now likely to cut its Cash Reserve Ratio (CRR) — the cash deposits that banks are required to keep with the central bank — by one percentage point from the existing 6.5% to 5.5%, said a senior official. This would release almost Rs 40,000 crore into the system. The source said the central bank might also decide to advance the date of maturity of market stabilization bonds. At present, around Rs 1.71 lakh crore is locked in these bonds.

However, policy makers are divided on the issue of infusion of liquidity because of concerns over inflation. Sources in the finance ministry said RBI is still maintaining a cautious stand on the issue as surplus liquidity fuels inflation, which is already hovering around 11%. However, the planning commission and a section of the finance ministry are of the view that inflation is no more a concern as global commodity prices have fallen sharply in the past month. Therefore, they argue that the government should focus on maintaining growth rather than tackling inflation, which would anyway decline in the next couple of months.

In its mid-year review of credit policy on October 24, RBI did not resort to any rate cuts saying that it will infuse liquidity in the system as and when it is required. In October so far, the RBI released around Rs 1,45,000 crore in the system. It cut the CRR by 2.5 percentage points from 9% to 6.5%, releasing Rs 1,00,000 crore. At the request of the central government, it also gave banks Rs 25,000 crore to finance the farm-loans waiver schemes. Besides this, it provided Rs 20,000 crore to banks to lend mutual funds to meet redemption pressure.

The banking source said that the government also released Rs 15,000 crore to its employees as the first tranche of the arrears of their salary hikes as per the sixth pay commission recommendation.

But all these measures could not help much as RBI sells dollar and mops up rupee from the market. As FIIs are buying dollars to repatriate money to their home countries, the dollar demand has gone up substantially. Besides this, the import bill far exceeds that of exports. This also leads to huge demands for dollars in the market. In the last one and a half months since the financial crisis has surfaced, rupee has depreciated by around 12%.

The bank official said that RBI is selling around $ 1 to $ 2 billion every day to meet the dollar requirements. But, in the process it sucks off liquidity of Rs 5,000 crore to Rs 10,000 crore every day. Therefore, he said that the measures taken by the RBI found insufficient. In less than three weeks of implementing the measures to infuse Rs 1,45,000 crore in the system, liquidity has almost dried up.
At the same time, the demands for funds from industries have also gone up substantially in the current financial year. As companies are not able to raise funds from any other means like initial public offerings, external commercial borrowings and foreign convertible bonds, the borrowing from banks are the only recourse to the, in the last one fortnight ending October 10, while the banks' deposits increased by Rs 27,221 crore, total credit went up by Rs 64,937 crore. This clearly indicates the demand for funds from industries. If the RBI does not arrange for the liquidity in the system, the economy will face a tough time and growth will be compromised, said the official.