With a view to easing the liquidity pressure in the banking system, the Reserve Bank of India on Tuesday cut the cash reserve ratio (CRR) by 50 basis points to bring it down to 5.5%. Deputy governor of RBI, Subir Gokarn, says that there was a need to address the liquidity deficit in the system and also push loans by bringing down the cost of funds for banks. Gokarn tells Shobhana Subramanian that open market operations (OMOs) are aimed at easing liquidity and are not targetted at easing the pressure on government yields.
How does RBI view the deleveraging of the eurozone in the context of the exposure of Indian entities?
Our estimate of Indian exposure to eurozone banks is around $60 billion and that includes trade credit. The Swiss and UK banks contribute another $87 billion. The way we see it, this $60 billion does constitute some risk, depending on the duration break up. But in the last couple of weeks, due to the long-term refinancing operations of the European Central Bank (ECB), European liquidity has improved dramatically and that?s reflecting in a number of parameters, including capital inflows into emerging economies. So, for the moment, it appears that the financial pressure in the eurozone has eased and that, in a sense, is providing time for governments to address deeper structural issues. The problem may re-emerge if a solution is not found, but for now the risk has come down somewhat.
How would you assess the ability of Indian entities to refinance their loans?
As long as the liquidity situation remains reasonably hospitable?and this is for both the US and Europe?you can looking at substituting the obligations. There would be a limit to tapping the US; that can?t happen endlessly. We saw some ECBs being financed by China, so that has become a channel. As a last resort, we can?as we did in 2008 when there were forex pressures?provide a kind of swap line to Indian banks. The swap facility from Japan of $3 billion, the unconditional part, cannot directly be used by borrowers and would have to pass through the sovereign. At this point, there seems to be enough liquidity in the world.
What about the rate at which the refinancing would have to take place?
What we?re hearing in our discussions is that while availability is not an issue, pricing is a little bit of an issue. There is a premium involved, but that?s something the system should be able to absorb. The main concern was whether there would be a sudden stop in the flow of credit and that risk has abated. Clearly, the depreciation impact on payments that are due immediately will be quite significant because, if you?ve borrowed at 44 to the dollar and you?re going to pay back at 50-51, then obviously there?s an impact. Indian companies have tended not to hedge because it?s another expense, but that?s a risk and you have to pay the price for it. I don?t think it?s at a point where it?s going to turn into some kind of systemic weakness.
Is there a case for raising interest rates on dollar deposits?
There?s always a case for some parity of treatment between the NRE and FCNR because there is some substitution; people who were using the FCNR are now switching to NRE deposits. The counter-argument is that when you don?t face a currency risk, there is no national identity to the depositor although it has to be made by Indian non-residents. There has been a lot of arbitrage noticed in the past and you are not really tapping into the constituency that you want to. The NRE, on the other hand, requires depositors to take the exchange rate risk and, as such, most people who put money in through that channel are not really visualising repatriating. That has been the case for using the NRE and not so much the FCNR. But the FCNR provides dollar flows and gives Indian banks operating abroad an increased channel of dollar funding. So, if you?re talking about dealing with dollar liquidity, that is one way it can happen. Based on the risk perception of deleveraging, it?s not needed right now, it?s a tool that is available if the need arises.
Are the country?s reserves of $290 billion adequate at this juncture, in the light of the $126 billion of short-term debt?
There was a Greenspan-Guidotti rule postulated many years ago, which was that reserves should be greater than the sum of the current account deficit and obligations of a residual maturity of less than one year. Basically, what it?s saying is do you have the capacity to meet next week?s potential outflows? By that yardstick, we are quite well-cushioned, we don?t have a problem. Looking at debt overall, which could be of longer maturity, as the benchmark for reserve adequacy would not be the way to do it.
How are you reading global liquidity and the ability of nations like France to borrow at yields lower than when they enjoyed a better rating?
Yields are a function of risk and liquidity and the downgrade has been more than offset by liquidity. The LTRO has essentially put a large amount of money into the euro banking system. The initial outflow of this money from banks has been into sovereigns and that has pushed sovereign yields down. So the ECB, while not responding directly to sovereign requirements, is, through liquidity infusion, supporting the sovereign borrowing programme. Banks are constrained in terms of capital adequacy, so for them to think of high risk deployments, like commodities, would be difficult.
Wouldn?t yields have been higher had it not been for the OMOs?
Yields would have been higher for a number of situations, if loan growth had been higher, for instance. But put that aside, infusing liquidity through OMOs increases liquidity in the system, which allows yields to soften. So, there is a clear correspondence. But if you?re asking why we?re doing OMOs when credit wasn?t flowing, it is to get banks off short-term dependence on funds. In a sense, you are freeing up R32,000 crore of cash and this can support roughly five times the amount over time. The multiplier effect depends on the state of business cycles and since, right now, the credit offtake isn?t that great, we don?t expect the impact to be felt immediately. There could be some impact on inflation, but the point here is to stimulate credit growth by bringing down the cost of funds, so that helps growth.
Don?t the OMOs encourage the government to borrow more?
It is a bit of a collateral consequence. Our motivation for OMOs is the liquidity situation. Assume a hypothetical situation where yields had been rising because of some demand pressure, but liquidity was within our comfort zone, then we wouldn?t have done OMOs, we did not see OMOs as specifically responding to yield pressures. The fact is that once OMOs are done, liquidity by banks can be used to support any channel of activity. So, to the extent they were not finding credit offtake, they were investing in government securities, so that pushed yields down.
What are RBI?s options if the government doesn?t come up with a credible plan for fiscal consolidation?
Much hinges on what the budget does and the Plan B will have to be articulated post that. We expect the government to come up with a plan and, although we haven?t done a numerical calculation, our scenarios for next year are based on some reasonable fiscal consolidation. The overall signal in terms of deficit reduction will be important as will be the magnitude and manner of change. For instance, are there caps on subsidies that are sustainable? Is there a large commitment to capex? Is there a focus on food productivity? The problem that the economy is facing is that the composition of growth is veering towards the public sector and more towards revenue spending or consumption spending. And so, not enough is going into investment. So, fixed capital formation has been declining and to boost this we need lower interest rates, which can come from lower consumption demand, especially government spending.