Float, be liquid

The Reserve Bank8217;s decision to cut the cash reserve ratio CRR to 7.5 per cent from 9 per cent is a timely step in the right direction. The Indian banking system has been facing a liquidity shortage of more than Rs 60,000 crore every day. From mid-September onwards, Indian banks have been borrowing this amount on the repo market on a daily basis. This extreme tightness in liquidity was becoming chronic and needed to be addressed immediately as firms were faced with a huge liquidity crunch. The RBI has done well to take urgent and immediate action to reduce the CRR by 1.5 percentage points, releasing Rs 60,000 crore into the market from Saturday.

With growth in industrial production in India in August down to 1.3 per cent, the fear of a slowdown is greater than before. In addition to this is the impending recession in the global economy that is going to affect our exports and economy in the coming few quarters. In the face of this situation it is important for growth to be put on the front-burner. The RBI should continue on this path of easing liquidity and making sure that there is adequate liquidity in the system. One of the reasons for the recent shortage in liquidity has been the RBI8217;s sale of dollars. A sale of 10 billion means that the RBI sucks out Rs 48,000 crore from the market. A cut in the CRR of 1 percentage point can

put back about Rs 40,000 crore into the system. In the coming weeks if the RBI continues to intervene in the currency market it should rapidly cut CRR rates down to 3 per cent, the statutory minimum.

The best policy now would be for the RBI to focus on providing enough liquidity to the market. The rupee should be allowed to float, that is, to find its own level. This would prevent monetary policy from being hijacked by the currency as it has been for many years now.

Domestic monetary policy requires today that liquidity should be eased. Manipulating the rupee, this time to prevent depreciation, conflicts with this objective of policy and the needs of the Indian economy. As other central banks in the world have done, at a time of a global liquidity crunch concerns about inflation need to take a backseat. That is not the biggest problem at the moment. Selling dollars to address the inflation issue is the wrong recipe because it makes the bigger problem 8212; that is, the liquidity crunch 8212; worse.