Liquidity situation to improve soon, says Rangarajan

The present tight liquidity condition is likely to ease soon, as a large portion of government spending happens in the last quarter of the financial year, according to C Rangarajan, chairman of the Prime Minister’s Economic Advisory Council.

“I do think that in the second half of the year, and particularly in the last quarter of the financial year, public spending increases and as a consequence, the liquidity situation will ease,” said Rangarajan. He was speaking to reporters on the sidelines of the Annual Bankers’ Conference (Bancon) 2010 here today.

“At the moment, government cash balances are much above the normal,” he said.

Liquidity has tightened sharply in the Indian banking system since October on low government spending and large cash withdrawals from banks during the festive season.

On November 29, the Reserve Bank of India (RBI) extended the second liquidity adjustment facilities that were ending on December 16 up to January 28. The RBI also relaxed the statutory liquidity ratio (SLR) by two per cent, compared with earlier relaxation of one per cent, to enable banks to borrow more from the repo auctions in light of the tight cash condition.

SLR is the minimum amount of bonds and other approved securities that banks have to maintain as a percentage of their deposits. It has been reduced to 23 per cent from 25 per cent temporarily.

Rangarajan, who believes capital flows are expected to increase, said the increased capital inflows would go towards financing the current account deficit, expected to be $45-50 billion, or about three per cent of the country’s GDP. “Therefore, I think, that up to about $70 billion in inflows should not cause in distortions.”

He is of the view that the central bank may not cut cash reserve ratio (CRR) as expected by a section of the market to tide over the present cash crunch.

“RBI will watch the liquidity situation. CRR cut is not the only way by which it can do it. There are other ways by which it can be done,” Rangarajan said.

He said a rate hike was not expected as inflation showing declining trend.

“There is a definite trend for inflation to fall. Indications are there because as far as primary articles, fuel and power are concerned, we have data of about two weeks and they do indicate food inflation and food articles (prices) have come down. If this trend can persist, then perhaps no further action may be required,” he said.

India’s annual food inflation eased to its lowest level in 18 months in the year to November 20, pressed down by lower prices of potatoes, pulses and vegetables, in line with policymakers’ forecasts. By the end of December, inflation should come down to 6.5 per cent, he said.