Not the right time

BS OPINION

Reserve Bank of India (RBI) Governor Y V Reddy's observation that all options were open in using the cash reserve ratio (CRR) as a short-term measure to manage liquidity is unexceptional.

The question, however, is whether this is the right time for a CRR cut. By all measures, liquidity in the money market continues to be abundant "" the call money rate rules below the repo rate, and banks continue to subscribe to the tune of over Rs 20,000 crore in the daily repo auctions.

At first glance, therefore, there doesn't seem to be any pressing need to inject a further dose of liquidity at the moment.

Nevertheless, there are a few early warning signs, which could, going forward, affect interest rates. One of them, mentioned by the Reserve Bank of India in its monetary policy review, is the pick-up in non-food credit since August.

The latest RBI figures show that the slowdown in credit disbursal in the first few months of this fiscal has been reversed, and in fact the rise in non-food credit in the last couple of months has been the highest in the past three years.

Moreover, with the recent restrictions on external commercial borrowings, it is expected that corporates which were earlier planning to borrow abroad may now tap the domestic markets to meet their requirements.

In other words, credit demand is expected to rise. On the supply side, the current account balance has turned negative and imports can only increase if the economy picks up momentum.

And if inflows from foreign institutional investors slow down, as seems to be happening currently, the main source of liquidity may no longer be as strong as earlier.

To be sure, FII flows are expected to rise again in the new year, but the point is that as the economy picks up steam, the flood of liquidity in the market will abate.

At the same time, with the raising of interest rates by the Australian and British central banks, the global interest rate cycle shows signs of turning.

While the US Federal Reserve is unlikely to raise rates soon, the effect of a US rate rise, when it comes, on foreign portfolio inflows into emerging markets may be a cause for concern.

In short, all the signs point to a bottoming out of domestic interest rates, signs that can be discerned quite clearly from the bond market's behaviour.

The outlook on inflation continues to be a source of comfort, with economists predicting an inflation figure lower than the current one by the end of the fiscal.

That considerably enhances the RBI's ability to continue to follow an easy money policy. Further, it will take a while before the capital expenditure plans of companies are translated into an increased demand for credit.

Theoretically, of course, there's a case for the RBI to reduce CRR and therefore reduce the pre-emption on bank resources, but the problem is that banks will immediately re-invest the extra money in government securities or even repos, where they don't seem to mind the pre-emption.

In other words, while there's no need to reduce CRR just yet, the RBI needs to keep its weapons ready to ensure adequate liquidity and keep interest rates low in the near future.