Economic Highlights

New Delhi, 28 August 2008

Money Supply Squeeze, Complex Banking

ASPRIN  TREATMENT  CAUSES  ULCER

By Shivaji Sarkar

The time has come for taking pragmatic and not hard decision to pep up the economy. But it is strange that people like Planning Commission Deputy Chairman Montek Singh Ahluwalia still harp on taking hard decision. Such decisions are likely to severely affect the country’s oil imports.

Two developments during the week point to the futility of the Reserve Bank’s hard decision of squeezing legal money out. In real terms, it has not reduced the money supply, as it comes from many other sources than the few known official or semi-official business routes.

Hard decisions have led to a situation where the banks are finding themselves in a tight liquidity situation. The situation of the oil marketing companies (OMC) – Indian Oil, Bharat Petroleum, and Hindustan Petroleum - is no different.

Both the banks and the OMCs have sought solutions that may have a long term-effect. The banks are looking at large companies for parking their deposits with them at 11.30% interest on one-year bulk deposits --- almost 150 basic points above the rates that banks offer to the retail customers.

Resulting in the domestic and international credit rating of the OMCs being downgraded. This has made raising debt costlier for them. They have turned to the Reserve Bank for a $ 4 billion (Rs 16,000 crores) foreign exchange loan. This is considered a cheaper option than looking to the commercial banks, which are charging very high lending rates. The oil companies have informed the Government that if the foreign exchange loan does not materialise it would disrupt the import of crude oil.

With the Reserve Bank raising the cost of money to the banks and forcing them to park a significant reserve with RBI, the banks have been left with little money to carry out their operations. The State Bank of India and the Bank of Baroda have turned to the Oil and Natural Gas Corporation (ONGC) for deposits of Rs 1700 crores and Rs 900 crores at 11.26% interest. These two deals indicate that the interests have moved up by 0.25%.

The banks are reportedly aggressively mopping up whatever money is available in the market on fears that the rates may move up to 12%. The tight liquidity condition is apparent. The banks are borrowing Rs 30,000 crores on an average from the RBI at 9% interest. Besides, the banks, as per the new norms, would have to shell almost Rs 9000 crores more out of their coffers and park it with the RBI. This is what raising of the cash reserve ratio (CRR) to 9% from 8.75% would mean.

Among other big deals concluded recently, the National Thermal Power Corporation (NTPC) has placed Rs 400 crores for 11.26% and a Tata group company deposited Rs 300 crores at 11.15%. The Clearing Corporation of India has also deposited Rs 50 crores at 11.20%.

It is not a bright situation always for the corporates. When they go to raise funds, they face difficulty. The Power Finance Corporation (PFC) failed to raise the entire Rs 700 crores through their 10.85% three-year bonds. It could raise only Rs 300 crores.

Further, the OMCs find raising foreign exchange loans, at a time when the rupee has risen to almost Rs 44 to a dollar, from the RBI cheaper than bank loans. If the Finance Ministry approves the process it would mean drawing the RBI into a commercial operation with all the related market risks. That is not the role of RBI.

On the other hand, it would also mean depriving the commercial banks of their normal bread and butter operations. Both ways it would be harmful for the economy. It would open the RBI to unwanted risks and lead to divesting the commercial banks of their normal mandated functioning.

The Finance Ministry would have to ask itself the rationale for such a devious operation. If this is accepted it would also mean that the RBI is exploiting the crisis created by itself to its own advantage. The RBI’s aim of bringing down the liquidity would also not be served, as indirectly it would be pumping the money into the market.

Clearly, the RBI itself is responsible for the crunch of the OMCs. The financial condition of the OMCs had improved in June, when the RBI had allowed special market operations (SMO), under which oil company bonds were made more attractive for banks to hold. But that facility was withdrawn on 24 July, when the RBI announced the new policy.

In short, the so-called squeeze therapy has created a convoluted economic scenario. A forced liquidity has brought the market to a halt. The recent warning by the international rating agency Moody only further testifies that.

This is the time the Government must mull over the age-worn concept of tightening the money supply. In times of crisis, the country needs liberation in terms of the money supply. Inflation has other reasons.

Every disease cannot be treated with aspirin --- money supply squeeze. It calls for a forward-looking banking policy so that the banks can survive to let the national economy thrive. ---INFA

(Copyright, India News and Feature Alliance)