Business

Baffling problem of liquidity crunch

Valiant efforts had been made by the Finance Ministry and the Reserve Bank of India to ease the liquidity crunch in the banking system arising mainly out of the heavy foreign exghange outflows. The foreign institutional investors are selling equities heavily in the bourses following redemption pressures in their home countries and the global financial crisis.

As a result there was an unsatisfied demand for dollars. The trade deficit was ballooning while the current account deficit in the external sector was increasing despite a steady growth in net invisible receipts. Since there were also withdrawals under other heads, foreign exchange reserves declined by $ 55 billion from end March to October 31 this year.

With an adverse turn of events since April this year the Finance Ministry and the monetary authorities have been on their toes to improve not only liquidity in the banking system but also minimise the outflow of forex reserves and even bring about a net improvement in forex funds.

In the earlier stages, the decisions related to a reduction in the cash reserve ratio of banks by 3.5 per cent to 5.5 per cent in stages and lowering of the repo rate by 1.5 per cent to 7.5 per cent. The limit for assistance to mutual funds through their banks has been raised from Rs. 20,000 crore to Rs. 60,000 crore which can be availed till end of March 2009. An advance of Rs. 25,000 crore has been made to banks under the loan waiver scheme on behalf of the Centre.

The monetary authorities have taken fresh imaginative measures to help exporters and those engaged in the realty and other sectors secure their forex and rupee requirements. Towards this end housing loan companies registered with the National Housing Bank can borrow on a short term and cheaper basis in foreign currencies on a stipulated basis. Many banks and housing finance companies have already lowered interest rates. At the same time, it has been decided to raise the ceiling interest rates for deposits in external accounts to attract inflows.

The emerging situation is being carefully watched by the Finance Ministry and the monetary authorities. The objective is to release further immobilised resources under CRR and also through repurchases of securities under the Market Stabilisation Scheme (MSS). The Centre’s borrowing programme too will be facilitated by the reissue of loans repurchased under MSS with a view to avoiding pressure on the money market.

The new developments in the coming months will have great significance. The deliberations of the G-20 members at the summit during the week end in Washington are also aimed at improving international liquidity.

The gravity of the recent developments in the external sector will be evident from the fact that forex reserves have declined sharply by about $60 billion in April-October. In the same period last year, there was an increase of $ 60 billion in forex assets and the RBI had to be busy effecting purchase of dollars for about $104 billion in 2007-08. As a consequence, the rupee appreciated to the high level of 39.26 in October last year which created problems for many export industries. With a heavy demand for dollars after April this year, the Indian currency has slumped to 48.98 on November 14.

The fluctuation in external parity of the rupee will be two sided as the current account deficit for April-September and even October-December are likely to be sizable and balance of payments deficits may emerge during this period though these will be absorbed by drawing down foreign reserves.

The fiscal and monetary policies should therefore aim at stimulating the economy, especially as inflationary pressures have latterly been subsiding and the inflation rate declined to 8.98 per cent for the week ended November 4 from 10.72 per cent in the earlier week.

With the prospect of this rate dropping to even 7 per cent in the near future it is estimated that the growth in GDP this year may be 7-7.5 per cent.

The Indian economy has been resilient and the global crisis can be prevented from reversing the growth process.

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