It is extremely important to provide the economy with ample rupee liquidity and ample dollar liquidity. RBI was making progress on rupee liquidity. What’s happened now? One week ago, banks had lent Rs 41,000 crore to RBI through the reverse repo, which gave the sense that the liquidity situation had eased. But on 29th October, banks borrowed Rs 58,000 crore from RBI. But even that wasn’t enough. On 29th (Wednesday), the last trade reported at CCIL showed a call money rate of 13.5%. We are back to a situation of very tight liquidity. This surely points to a failure of policy at RBI. The repo rate is supposed to be 8% and so the call money rate is supposed to stay below 8%. But banks clearly lack the securities required to obtain money at the repo. RBI needs to urgently make much deeper changes so as to ensure this is always the case. This requires three things. First, CRR needs to be cut, perhaps by 200 basis points. Second, SLR needs to be cut deeper, by 400 basis points. Third, oil bonds and fertiliser bonds need to be made repo-eligible. These three steps, put together, will ensure that the short-term rate will not go above the policy rate.
When RBI embarked on the policy activism in early October, the market was pleasantly surprised. In the period after this, there has been a loss of credibility. Confidence in RBI’s ability to understand problems and solve them has been somewhat dented. This is extremely damaging to the economy. If the market perceives that liquidity at the short end is going to periodically dry up, then firms will hoard liquidity, and be averse to lend. The ‘maturity transformation’ that banks do—of borrowing at the short-term and lending at the long-term—critically relies on the confidence that prices and quantities at the short-term will work out okay. Each episode of an outage on the money market that RBI subjects us to leads to greater risk aversion on the part of lenders, and exacerbates the credit crunch. These problems are important, and have a major impact upon the outlook for business cycle conditions. RBI must undertake fundamental reform of its operating framework and its policy making process right away. These fundamental reforms must be conveyed to the market in unambiguous terms, to reassure the market that new thinking is firmly in the saddle.