Domestic and Foreign currency liquidity

Global markets  are currently  going through  a worst phase due to the failure of top banks in US and Europe and the attendant financial crisis. Indian stock markets are following the direction of global markets and the end result is obvious. For four days in a week stock market is ending up negative by substantial margins. From a level of 14000 not  long ago, SENSEX lost more than 3500 points and is currently at 10500 points on 16th 0ct 08. FII outflows are unabated. Indian investors are scary about the developments around and panic selling is taking place. Earlier, in order to control the high level of inflation, CRR ( cash reserve ratio ) was hiked several time to restrict the fund supply in the market. Present financial crisis has added more to the woes of liquidity. Call money rates peaked and went above 23 %. In order to overcome the major problem of liquidity crisis, RBI has revised CRR downwards by 1.5 % recently which helped to some extent in bringing down the call money rates below 10%. But still banks do not have enough funds to meet the credit requirements from various sectors. As the Indian stock market has fared very badly  during the last week, with the invetors' confidence eroding fast, and credit crunch obstructing growth, RBI announced a series of measures last evening ( 15.10.08) to boost the domestic and foreign currency liquidity. The measures are briefly as follows ;

a) Cash Reserve Ratio (CRR) ,i.e., the ratio of demand and term deposits to be maintained as cash balance by the banks with RBI, which is presently 7.5 % ,has been reduced to 6.5 % effective from 11th Oct 08. This will release, additionally, about Rs.40000 crores into the financial markets.

b) The investors are making demands on mutual funds for redemption of their investments. To help the liquidiy requirements of Mutual Funds, RBI has decided to conduct a special  14 day - Repo for lending funds to banks who will in turn lend to mutual funds. Under this arrangement for fourteen days, every day RBI will conduct the repo facility upto a cumulative amount of Rs.20000 crs  and banks may avail this facility exclusively for the sake of Mutual funds, to the extent of  0.5 % of the (bank's) net demand and term deposits.

c) RBI introduced a mechanism of Special Marketing Operations (SMO) for public sector oil companies in June - July 08 for meeting the extraordinary situation ,then prevailing in the money and forex markets on account of spiralling international crude prices. A similar facility will be instituted once the oil bonds become available.

d) Under Agricultural Debt waiver and Debt Relief Scheme, Government had agreed to provide to commercial banks, RRBs, and  Co operative institutions, a sum of Rs.25000 crs as the first instalment. RBI agreed to provide this sum to the lending institutions immediately.

e) To encourage inflow of foreign currency funds, the interest rate ceiling on FCNR(B) deposits , has been raised to LIBOR plus 25 basis points from the present LIBOR minus 25 basis points for respective foreign currencies.  Similarly the interest rate ceiling on NRE term deposits for one to three years maturity has been raised to LIBOR plus 100 basis points from the present 50 basis points over LIBOR, applicable to US dollar.

f) Banks will be allowed to borrow from their overseas branches and correspondent banks up to a limit of 50 % of their unimpaired Tier 1 capital as at the close of previous quarter or USD 10 mn whichever is higher, as against the existing limit of 25 %.

g) FII investment  limit in corporate debt is doubled to USD 6 bn thereby providing good arbitrage opportunity for FII s which will in turn improve the dollar liquidity.

The above measures are expected to increase the fund supply in the financial markets and to instill confidence  in the investor community.

So far as the forex market is concerned, the foreign inflows have dried up. The FII outflows, corporate buying of dollars and foreign banks buying dollars to take advantage of arbitrage in NDF market overseas have been putting tremendous pressure on rupee. The present dollar - rupee range is 48.50 to 49.00. To prevent volataility in the market RBI's intervention by selling dollars through public sector banks is helping to some extent.  With the above said measures, if more liquidity is infused into the banking system, RBI is expected to intervene more aggressively by selling dollars to prevent volatility in the forex market.