October 21, 2008 10:33:22 pm
The private sector always has a gloomy view about Indian government, but the economic policy establishment is now looking better than anticipated. The prime minister’s unequivocal statement in the Lok Sabha helped, though it fell short of announcing a categorical plan to protect the banking sector. He was quite thankfully clear, though, about the gravity of the crisis, its impact on India, and on the government’s intention to maintain liquidity in the markets. In the last one month, the performance of the finance ministry, RBI and SEBI has been impressive.
Liquidity has been introduced: the CRR has been cut 250 basis points, a de facto cut of 100 basis points on the SLR has been achieved, capital controls against participatory notes were reversed and the repo rate has been cut 100 basis. C.B. Bhave of SEBI on Monday announced that the board will be looking hard at selling pressure from FIIs offshore. This performance exceeds all expectations. We have begun to see glimmers of the policy-making capability that a trillion dollar adolescent market economy requires.
While these moves are in the right direction, much more needs to be done. On the subject of increasing rupee liquidity, while the money market is right now flush with funds, this could easily change in a few days. The critical task that is needed is to recognise that oil bonds and fertiliser bonds are indeed government bonds, and make them repo- and SLR-eligible. The SLR needs to simultaneously be cut to 20 per cent. On the subject of increasing dollar liquidity, work needs to take place on two fronts. First, capital controls need to be eased: by lifting restrictions on NRIs bringing in money, and placing investments by FIIs in rupee-denominated bonds on par with FII investments into equities. Further, RBI needs to set up a clear mechanism through which it will use reserves to alleviate the crisis of dollar liquidity that Indian firms are facing through a clear rules-based mechanism. Simultaneously, RBI needs to aid in the removal of currency mismatches by fixing the currency derivatives market. Restrictions that hobble SEBI-regulated exchange-traded currency derivatives need to be removed. RBI needs to supple-ment the orders on the currency derivatives market (at fair prices) so as to increase the depth of this market while not distorting market price discovery. Finally, a war room needs to be set up to monitor banks, to work with banks to set up liquidity plans and solvency plans, and to gear up to deal with the possible threat of bankruptcy to one or more banks in the coming year or two.
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