RBI and the Finance Ministry are fighting a battle to ensure adequate liquidity in the system, which has turned from abundance just four-five months back to a stranglehold that could turn into solvency disaster. The apex bank has cut cash reserve ratio (CRR) by as much as 250 basis points in the first half of October injecting a record Rs 1 trillion into banks, offered Rs 20,000 crore through special 14 days Repo auctions to help funds-starved mutual funds, released Rs 25,000 crore to banks as reimbursement of farm loan write-offs, relaxed effectively SLR requirements, announced twice a day LAF and allowed hikes in NRI deposit rates. It is noteworthy that current liquidity boosters constitute a complete turnaround from the approach comprising a war on surfeit of liquidity by consistent measures aimed at making money more costly to users just three-four months ago on which we wrote an Edit (see Projectmonitor 1-7 July).
The liquidity vice-like grip has come about because of first-time experienced steep decline in forex reserves due to FII repatriations and global financial turmoil. Thus, the forex reserves dropped $9.9 billion during the week ended 10 October, over $7.9 billion in the preceding week. The massive drawdown of around $18 billion forex reserves in two weeks time only with resultant decline in rupee resources in the system and no immediate prospect of a reversal must have raised alarms in RBI forcing it to adopt exceptional measures in this extraordinary situation. Stock prices have plummeted and FIIs were net sellers of equity/debt to the extent of $2.8 billion in first ten days of October, $1.3 billion in September and a little less than $10 billion in 2008 (till 10 October). By the way, a major reason behind the massive dollar sales by RBI is its concern to contain volatility in forex markets and prevent free fall in rupee value, which nevertheless lost heavily against dollar, with yearly depreciation put at 19 per cent by 10 October, against 7 per cent appreciation just six months back.
Crunch of fund is relatively more harmful than its excess as it immediately leads to solvency problems for banks and financial institutions and this spins off into lower as also costlier funds for corporates. This is obviously not congenial to a growing India that has lined up a huge infrastructure capex programme. Therefore, despite relatively high inflation and M3 and bank credit exceeding projections, loosening monetary policy finds support on solvency and growth counts.
We may note here that the main reason behind liquidity crunch now is forex outflows, like forex deluge in earlier surging liquidity. So, the monetary policy would have to encompass a stance on exchange rate and forex market operations also, in order to make it more comprehensive and sustainable. Unless this is in place, any policy direction on rates would remain contingent on forex flows.