After the announcement of a pause to monetary policy tightening, the Reserve Bank of India (RBI) has been applying the liquidity management tool of quantity easing operations through drastic cuts in cash reserve ratio (CRR), rather than easing of repo rate.
The CRR instrument was also supplemented by open market operations (OMO). The cuts in CRR and OMO no doubt augmented the lendable resources of the banking system on a more enduring basis than overnight injection of liquidity through the Liquidity Adjustment Facility (LAF) window, though the second round impact of these operations is yet to be fully felt in the system through monetary indicators.
The CRR cuts came close to each other by a sum of 1.25 percentage points, releasing primary liquidity of about Rs 80,000 crore into the banking system.
The RBI conducted OMO during the last two months, injecting another Rs 52,800 crore, augmenting primary liquidity for an aggregate amount of Rs 1.32 lakh crore. The daily injection through LAF nevertheless continues to remain high.
Sources of Liquidity Strain
The liquidity strain in the system during January and February seems to have been on account of a combination of two major factors (Table).
First, the RBI's forex market interventions, as reflected through variations in net foreign currency assets, drained out Rs 1.29 lakh crore and, second, the governments securities issuance, net of coupon payments and redemptions, another Rs 1.35 lakh crore.
Hence, the cuts in CRR and OMO helped desterilise forex market interventions and supporti the borrowing programme of the government.
In addition, variations in major monetary indicators such as currency, bank deposits and credit also contributed to a negative flow of around Rs 0.91 lakh crore.
It is not surprising, therefore, that the system draws continuously more liquidity through the LAF window, despite the RBI's cuts in CRR and OMO operations.
The year-on-year M{-3} growth so far during the current financial year dwindled to a low of 13.5 per cent, compared with 16.7 per cent in the previous year, and the reserve money growth also decelerated to 11.7 per cent against 19.7 per cent in the previous year.
Monetary-Debt Management Nexus
One inherent conflict in the RBI's operations is that it is really difficult to distinguish its monetary operations from debt management operations. The recent liquidity augmenting measures are intended apparently to ease monetary conditions to enable the banking system to expand its credit portfolio to productive sectors of the economy. But, what seems to have been actually achieved at least thus far is to see that the extraordinary appetite of the government to borrow from the market sailing through smoothly.
The long-term and medium-term gross borrowings of the government so far during the current financial year amounted to a staggering Rs 4.98 lakh crore against Rs 4.37 lakh crore in the previous year and the net amount to Rs 4.24 lakh crore against Rs 3.25 lakh crore over the same period. On top of this, the net outstanding value of treasury bills of all maturities, as on March 2, 2012, went up by Rs 1.14 lakh crore — which may not be reflected directly in market borrowings, when the Budget is presented.
As on February 24, 2012, the financial year variation in SLR investment by commercial banks increased by Rs 2.43 lakh crore or 16.25 per cent compared with Rs 1.02 lakh crore or 7.4 per cent in the corresponding period of the previous year.
The bank credit, on the other hand, expanded by a substantially lower amount of Rs 4.65 lakh crore or 11.8 per cent compared with Rs 5.6 lakh crore or 17.5 per cent in the previous year.
Therefore, the current trends amply support the view that the debt operations of the government have been crowding out the credit flow to private sector, in particular to priority sector segments, as has been commented upon widely in the press recently.
What is expected of RBI?
It is really commendable that in the context of ruling uncertainty about fiscal consolidation and containment of borrowings, the RBI has given a pause to using the interest rate instrument for monetary easing. That the CRR and repo rates were left unchanged at 4.75 per cent and 8.5 per cent, respectively, in yesterday's mid-quarter review, a day before the Budget, did not come as a surprise.
The press release of March 9 announcing the CRR cut succinctly indicated that the review will (only) provide an assessment of macroeconomic conditions and that the market should not expect any rate cuts too soon.
Since the public debt seems to be already crowding out credit to private sector, it is only proper that the government incurs the necessary cost of raising such additional resources. The strong stand of the RBI management on this issue, of not acceding quickly to a cut in policy rate in the current juncture, is indeed laudable.
Once the proposed Bill for the setting up of the independent debt management office by the government is implemented, the the RBI is likely to be relieved of this inherent conflict in its operations.
(The author is Director, EPW Research Foundation. The views are personal.)