CRR hike as double whammy

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shows a significant decline during February 2008, when the monthly premium rates turned negative from earlier levels. Clearly, there is reason to believe that RBI had used the swap route more often during this time. By logic, a sell-buy swap transaction may be ruled out, as the rupee was not under any pressure at the time.

What if RBI was using the outright forward purchase route during this time? The only difference could have been that, there could have additional liquidity injected into the system in lieu of forward purchase at a future date, that RBI had to take care of.

There we have the answer to the question of why we think CRR is being sought to be used as a double whammy. Both the buy-sell swap and outright forward purchases that RBI may have taken recourse to during October 2007-February 2008 have to be neutralised through other measures.

Interestingly, as the table (alongside) on monetary and exchange rate management shows, the Omo route has also (surprisingly) injected liquidity during this period, instead of withdrawing liquidity. Thus, the only option left to RBI was to use CRR as an additional instrument to withdraw liquidity. Clearly, the subsequent CRR hikes have been a very smart move by RBI, but the intended purpose was perhaps short-term monetary management.

In the past, RBI has clearly shown its apathy to swap transactions. To quote the bank, “The extent to which such swaps can be undertaken depends on the depth of the forex market. The recent experience of building up of forward purchase obligations to meet repayment of Resurgent India Bonds (RIB) showed that such operations could result in pressure on the market to meet deliveries. Moreover, sell/buy swaps, even when undertaken on a large scale, do not have any lasting impact in correcting distortions in forward premia. Also, the cost of swaps, as captured in the accounts of the Reserve Bank, has increased with the appreciation of the rupee”.