Business Standard

There's genuine need to cut reference rates

MID-TERM MONETARY POLICY 2008-09/ Viewpoint

Romesh Sobti
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It has been a roller-coaster ride! Inflation, which was seen as a major issue in the previous credit policy in July 2008 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. The focus has now shifted to addressing growth and liquidity concerns.

Although the Reserve Bank of India (RBI) reversed its earlier cash reserve ratio (CRR) and repo rate hikes from peaks of 9 per cent to 6.5 per cent and 8 per cent, respectively, there are no clear signs of restoration of normalcy yet.

The main issues that were presumably engaging RBI ahead of the 24th credit policy in October were restoration of credit confidence in the system 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 CRR and/or key reference rates but to provide sector-specific support, mainly to export-oriented units, small-scale industries (SSI), small and medium enterprises (SMEs), 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 (where the rupee has posted a new low of 50.15 in the morning trade, ahead of the policy) while there is a genuine need for reduction in reference rates to cool down deposit and lending rates.

There is also need to get an effective solution to arrest the rupee fall (by tapping NRI resources) as recent measures of relaxation in ECB norms and token increase in NRI rates have not yielded the desired results.

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 SSIs/SMEs and agriculture-oriented units through Sidbi or Nabard and foreign currency funding to import/export-oriented units through Exim Bank. This can be facilitated through special refinance schemes for banks.

To arrest the fall in the stock market, 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.

Given the comfortable liquidity in the system, leaving the CRR/SLR rates unchanged is understandable, but, the main issue -- the dollar/rupee exchange rate, which is draining liquidity -- requires to be dealt with. RBI’s aggressive intervention in the foreign exchange market has already removed most of liquidity provided to the system. If liquidity remains tight in the coming days, then RBI might look at cutting CRR and/or SLR rates.

Call rates, which are ruling in the 6-8 per cent corridor, would have guided 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 RBI has considered adequacy of the liquidity and its cost at the current level as satisfactory and would be prepared to act when warranted.

Romesh Sobti, Managing Director, IndusInd Bank

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