Managing liquidity will be key for RBI as liquidity will progressively deteriorate, says Hitendra Dave, head of global markets India, HSBC Bank. In an interview with Aparna Iyer, Dave says inflation level doesn?t allow RBI to cut policy rates but the liquidity problem will prompt them to continue with CRR cuts and open market bond purchases. Excerpts

Do you expect RBI to cut rates in late October?

Rate cut depends on whether RBI wants to boost animal spirits of the economy, reinforce stock market sentiment or does it want to see through its stated objective of lowering inflation to levels which are compatible with the long-term goal.

If the intention of the policy is to lower inflation to 5%, there is no way you can justify a cut. The economic case for rate cut is very weak. The only case is that the government has taken a lot of steps and RBI should support. That is a judgement for the governor to make. I think the impact of a rate cut per se is overestimated.

Do you think RBI will cut CRR considering it is at nine-year low?

RBI now has an official stance on liquidity which is that liqudity will not be allowed to go outside the 1% of NDTL. Whenever that happens, we know RBI will step in. There is nothing wrong in CRR going below 4.5%.

Liquidity in terms of money creation comes entirely from capital flows. But our system loses liquidity every six months through the informal economy and due to general preference for cash. The amount of liquidity that leaves the system is around R8,000-10,000 crore a month and is growing.

That means every six months, the system needs 1% CRR cut or an equal of OMO bonds buys or a combination to avoid disruptions. Liquidity is only going to deteriorate now progressively right up to March. Therefore, the choice is between OMO and CRR or both. Or they can buy dollars.

But buying dollars in such a market is not possible…

If our trade deficit is going to be around $10 billion a month and if invisibles make up for around $5-6 billion, then there is still a gap and we cannot expect to get large amount through FII, FDI, and ECBs. We need $60-70 billion to fill the CAD gap. At this juncture, if we make an assumption of getting more than $60-70 billion, it is too optimistic. So RBI clearly cannot buy dollars, and they will have to continue to cut CRR or do OMOs because there is no other way to infuse liquidity.

Will the 2 lakh crore government borrowing sail through smoothly?

I think if it is 2 lakh crore, there is no problem because you have buyers lined up. Bank credit is weak right now and you have natural bank appetite for bonds. There is reasonable demand from EPFO, insurance companies and even FIIs are holding larger chunks of bonds.

Supply would have been an issue if RBI had not done OMOs earlier. But the net borrowing of R4,90,000 crore does not allow a rally in bonds. The bond market does not need OMOs right now. But given the outflows, liquidity infusion will take place through OMO or CRR.

Do you think RBI?s forex policy has served well when the rupee has swayed between 49/$ and 57/$ in just eight months?

I think the fall of rupee to 57/$ is a good thing that has happened. In an environment where growth challenges are severe, this acts as a tailwind by boosting exports.

The negative part is those who have just invested in the country and you have lost 20% value, you do get psyched. But most foreign investors are sophisticated and know the risks. ECBs are done by big companies and they know the costs abroad and domestically.