IMF team moots long-term bond to suck out liquidity

The debate on the use of foreign exchange reserves for infrastructure financing has taken a fresh twist with a visiting International Monetary Fund (IMF) team suggesting floating of a long-term bond to squeeze excess liquidity in the domestic market. The suggestion was made in an informal discussion with the Reserve Bank of India.

The suggestion, if accepted, will serve two purposes "" tackling the rising inflation and mobilising resources for infrastructure financing without impacting the reserves.

The long-term bonds, with a maturity of 20-25 years, could garner funds from the domestic market and use it for infrastructure. While excess liquidity could be sucked out in one go, the government will not have to keep on shelling out the interest cost on the market stabilisation bonds (MSBs).

Besides, banking sources said, the MSBs are not very effective in absorbing liquidity as the money sucked out through treasury bills get rolled back into the system over and over again. The long term bonds can effectively tackle the growing money supply with the public and its impact on the inflation.

The bonds could be subscribed to by life insurance companies, trusts and pension funds. Besides, those banks, which have been lending to the infrastructure sector, will also be able to tide over the asset liability mismatches by subscribing to the bonds. The banks, which will subscribe to the bonds and create long term assets, could take long term refinance from RBI in case credit pick-up is too high.

The Reserve bank of India, quoting the conditionalities of the IMF, had earlier ruled out the possibility of using forex reserves for domestic on-lending. According to RBI, reserves are meant for unforseen circumstances like the present situation of oil prices.

Sources added that while oil prices have touched above $53 a barrel, forex reserves are acting as a big cushion both for supporting the spot rupee to minimise the outflow on account of oil payments and to take care of oil payments. In the process, domestic interest rates, inflation and the liquidity have been managed in tolerable extent till date.

The IMF team has discussed various issues pertaining to the health of financial sector and banks under Article 4. It is learnt to have expressed concern on the rising rate of inflation in India.