The Reserve Bank of India’s (RBI) decision to spring a surprise on the markets was a clever move. The rate hike applies only to Marginal Standing Facility (MSF) by a steep 200 basis points, and repos are limited to Rs 75,000 crore.
There is no change in the cost of accessing the repo window, which is expected to influence the call money market and the system; the MSF is an outlier in the rate structure being in the nature of exceptional finance.
The move gives the impression of not raising the cost of borrowing, but still making it possible for the retail loan rates to go up. For the central bank, it is a case of having the cake and eating it too.
However, the markets have correctly interpreted the move as a hardening one. What is surprising is the ceiling on the resources available at the repo window at 1 per cent of net demand and time liabilities (NDTL) of the banking system, now at Rs 75,000 crore.
The changes alter the fundamentals of the revamped Liquidity Adjustment Facility (LAF) introduced a couple of years ago. Is it not time for a review of its working?
Under the MSF, the eligible entities can avail overnight up to 1 per cent of their respective NDTL outstanding at the end of the second preceding fortnight.
If, as a consequence, Statutory Liquidity Ratio (SLR) holdings fall below the requirement up to one per cent of their NDTL, banks will not have to seek a specific waiver for the default in SLR compliance.
Thus, MSF will help banks when their SLR holdings are just adequate to meet the legal requirement, and which have been borrowing in the call money market.
Others with surplus securities may not be able to borrow to the hilt from the repo window and lend, utilising arbitrage opportunities.
There has been a suspicion that they are playing in the forex market also.
Coupled with the recent restrictions on forex transactions imposed by the RBI and SEBI, the measures are likely to have a sobering effect on the market.
NRI BOND ISSUE
The RBI needs to take some further policy decisions. It has already announced the floatation of government securities for Rs 12,000 crore. It is well advised not to carry out debt buybacks hereafter to help government’s gilt issues.
They violate the spirit of the Fiscal Responsibility and Budget Management Act (FRBMA).
The Act is not justiciable and its provisions can be waived in case of emergencies.
This can be taken advantage of by the government, which, in any case, is not finicky about legal or constitutional niceties.
If the market demands high yields the securities may be taken by the central bank on its books initially, to be unloaded in instalments later when conditions are favourable. This practice was followed successfully in the past before the FRBMA.
The hardening of interest rates and yields as a consequence of the policy changes should be a source of encouragement for foreign institutional investors to invest in securities. It is their desertion of the debt market that led to the current crisis.
There is a proposal to issue sovereign or quasi-sovereign bonds to mobilise forex from NRIs. In 2000 India Millennium Deposits (IMD) fetched $5.5 billion at a rate of interest of 8.5 per cent, 7.85 per cent and 6.85 per cent for US dollars, pound sterling and Euro, respectively.
The rates were 1.75 percentage points higher than the six-month LIBOR for the currencies. Now, LIBOR for 6 months for US dollar is 0.40350 per cent. The old formula will not be successful now. According to some experts, if currency risk is to be hedged, the borrowing cost may be around 8.5 to 9.0 per cent.
FCNR DEPOSITS
Would it not be better instead to relax the interest rate restrictions on Foreign Currency Non-Resident Deposits, as suggested by me earlier?
The RBI may also think of waiving both SLR and Cash Reserve Ratio (CRR) requirements on incremental deposits in all the three NRI deposit schemes to make it possible for banks to mobilise substantial amounts and lend them to Indian entrepreneurs on attractive terms.
(In the case of IMB there was a waiver of CRR, but not the 40-per-cent SLR.) Unlike the bond that will be a one-off transaction, the deposit schemes will continue to attract funds.
It may be recalled that most of NRIs did not repatriate their funds at the time of the redemption of IMBs. Instead they parked them in NRI deposits.
Any forex collected is likely to be added to the reserves of RBI, where it will be invested in low-yielding treasuries and deposits of international institutions abroad. It will mean a substantial outgo of forex from the country.
If the SBI is asked to handle the floatation and deploy the deposits in forex currency loans, like it was on the last occasion, the question of compensating it for exchange losses at the time of redemption will arise. The transaction cost for bonds will be more than for NRI deposits.
The RBI Governor has shown that he is no lame duck chief of the central bank.
He has proved himself to be a knight in shining armour -- riding a black horse (LAF) with a swinging sword (interest rate) to save the rupee from dishonour at the hands of the villain, the dollar!
(The author is a Mumbai-based economic consultant.)