RBI steps in to ease liquidity pressure

Interest rate on foreign currency deposits hiked by 25 basis points.

Amid mounting pressure for a cut in banks' cash reserve ratio (CRR), the Reserve Bank of India today took yet another step to ease liquidity in the financial system.

The central bank hiked the interest rate ceiling on foreign currency non-resident bank (FCNR-B) deposits by a quarter percentage point.

Ahead of its annual monetary policy on April 18, the RBI has already managed to ease the pressure on liquidity by continuously sterilising the dollar inflow.

Over the last six weeks, it has bought about $6 billion from the foreign exchange market and released over Rs 25,000 crore into the system. The foreign exchange reserves, which were $140.429 billion on February 10, rose to $146.159 billion on March 18.

This, coupled with unwinding of the market stabilisation scheme (MSS), has brought down the overnight call rate from its three-and-a-half-year high of 8 per cent last month to less than 6 per cent today.

As a tell-tale sign of liquidity easing, the RBI today mopped up Rs 4,745 crore through the reverse repo while there was no taker for funds at the repo window.

The central bank infuses funds into the system through the repo window at 6.5 per cent and absorbs liquidity through the reverse route at 5.5 per cent. The average daily injection of funds through the repo facility last month was over Rs 15,000 crore. It came down to about Rs 2,000 crore in mid-March. Increased government spending would ease the situation further, analysts said.

Hours after RBI Governor YV Reddy's meeting with the Indian Banks' Association (IBA), the central bank notified that FCNR deposits would now be accepted at Libor (London Interbank Offered Rate) as against a quarter percentage point below Libor.

Reddy heard the IBA representatives led by its State Bank of India Chief AK Purwar for about half an hour but did not make any comment. Special Secretary (Banking) Vinod Rai too attended the meeting signalling the North Block's active involvement in easing the pressure on liquidity.

Bankers had in their meeting with Finance Minister P Chidambarm last week said a one percentage point cut in CRR would release Rs 20,000 crore into the banking system but today they did not make any pitch for a CRR cut.

Apart from Purwar, Citibank India Head Sanjay Nair, IDBI Chairman VP Shetty and IBA Chief Executive HN Sinor attended the meeting.

"Liquidity has improved for the time being. However, we are not sure how long it will last. Both the finance ministry and the RBI will keep a close watch on the scene. The ministry officials are expected to take stock of the situation on April 4 when Reddy will be in Delhi," said a source.

Reddy has said there is no structural impediment for the resource constraint and the liquidity strain is a temporary phenomenon. RBI has stopped selling bonds under the MSS and unwound about Rs 60,000 crore worth ofsecurities in the past few months.

Year on year, bank credit has increased by 32.3 per cent or Rs 3,46,329 crore. In contrast, deposits year-on-year have grown by 17 per cent or Rs 2,90,048 crore.

"This is not sustainable. Banks will have to rein in the credit growth. Otherwise, they will run the risk of creating an asset bubble," pointed out an analyst. Purwar also said the current pace of credit growth could not be sustained.

The latest move on raising the FCNR (B) deposit rates will help banks mop up foreign currency loans paying higher interest rates. The six month US dollar LIBOR is currently 5.06 per cent.

These deposits are accepted for up to five years and are denominated in all major currencies -- US dollar, yen, pound, euro, Australian dollar and Canadian dollar.