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Tuesday, June 15, 2021

Learn, be liquid

A pro-active RBI should be ready to step in as a lender of first resort

Written by Theindianexpress |
October 13, 2008 1:58:14 am

The present global turmoil is the first time India is being sucked into a full-blown financial crisis. The Indian economy is far more globalised than ever before. This financial crisis will impact India not merely because our banks have or do not have direct exposure to the US sub-prime housing sector, but because Indian firms have far more exposure to the world than ever before. Our policy-makers will have to be ready to take prompt steps with utmost urgency in this difficult and challenging environment. It is important that the government and policy-makers do not become complacent with the apparent closed nature of the Indian financial system and the strength and resilience of the real economy until now, and that they be ready to take any steps that are needed to save the crisis from deepening, however unconventional they may be. Financial crises can unfold with terrifying speed, as they are doing in the US at present. Learning lessons from the way financial crises have played out in other countries in the past can help policy-makers to be prepared for what might come next.

In the coming week the top priority of the RBI will be to ensure adequate liquidity. Over the last one week we have seen some of the biggest falls in the Sensex and the rupee. Even as the RBI struggles to put liquidity into the system, it would not be surprising if in the next few days the banking system continues to face further liquidity shortages. FIIs and mutual funds face redemption pressures. Indian firms which have operations abroad will try to borrow here.

In the next few days the RBI should further reduce the cash reserve ratio. The cuts in CRR last week will bring some relief to the system but it will not be enough to take account of emerging tightness. The RBI should be prepared for further, sharp cuts in the CRR. Homeopathic cuts may not be enough. Similarly, the RBI should consider cutting the statutory liquidity ratio substantially. Oil bonds should be made SLR eligible. This is the time to put the issue of liquidity ahead of all others. With these steps, along with a pro-active RBI that should be ready to step in as a lender of first resort, the extreme tightness in liquidity can possibly be tackled.

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