FE Editorial : It’s a squeeze

The Financial Express
Posted: 2008-10-08 21:33:18+05:30 IST
Updated: Oct 08, 2008 at 2133 hrs IST

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: While there is no reason to panic about the medium-term strength of the Indian economy, and that includes the financial sector and credit markets, concerns are building up about problems in the short term. The symptom of the problem is evident in the sharp fall in the stock markets and a tightening up of liquidity. By some accounts, overnight borrowing rates between banks are around 18% even though the repo rate is 9%. Of course, banks in India don’t suffer from the sort of crisis of confidence in one another like banks stricken with bad loans in the West face. So, clearly, there is a shortage of liquidity in the system. Some of this also has to do with the rapid reversal of FII flows, which also explains why the stock market has been heading downwards. RBI’s move to slash CRR by 50 basis points is a good move which will inject some Rs 20,000 crore into the system; yet it may not be enough. It will certainly do nothing to bring interest rates down, something which RBI must move to act upon in the October 24 monetary policy review.

The government can also release liquidity by releasing funds for civil service salaries in line with the Pay Commission recommendations. It can also release advance tax collections. And release the first tranche of cash to banks for the loan waivers it has already granted to farmers. The possibilities are many. The government must react fast. Unfortunately, some of our policymakers have been a bit behind the ball over the last few months as first inflation and then the global financial crisis have hit the economy. RBI erred in raising rates and clamping down on liquidity in an ill-thought out move to contain inflation. As these columns have repeatedly argued, inflation is an imported commodities based phenomenon this time around. Interest rate hikes were the wrong medicine. Now, with oil down to $90 a barrel and commodities prices crashing worldwide, inflationary expectations in India have been lowered, without any assistance from domestic monetary policy. But the credit tightening is hurting badly. The government and RBI have to now play catch up, but in the interest of the economy, one hopes that they are on the ball soon enough, preferably in the monetary policy review on October 24.