So why the rush to raise foreign currency through NRI bonds? Ostensibly, the millennium deposit scheme (as the bond proposal is called) is being floated entirely on the initiative of the State Bank of India. However, what the retail investor is to be offered are sovereign bonds; the foreign exchange risk (likely at the time of redemption payment) will be borne by the Reserve Bank. The State Bank is not the prime mover;there is policy inspiration behind it.

On the face it, the millennium deposit scheme appears to be a measure of abundant caution against the uncertain forex outflow scenario facing the country. There is the unpredictable oil import bill: how high will it rise? There is also the uncertainty attached to foreign portfolio investment. Finally, there is no knowing if interest rates in the US will rise (though with high oil prices slated to slow American growth somewhat) these are unlikely to be hardened. Thus, India's forex reserves could do nicely with a topping of a couple of billion dollars.

There is substance in this line of reasoning. But there is more to the millennium deposits than meets the eye. Consider the reported observations of the State Bank's chairman. Bank credit is expanding: ``we need additional resources to support the credit pick-up''. This suggests that millennium deposits will more than shore up forex reserves. They will create liquidity in the Indian financial system.

In plain speak, this means that illiquidity is slated to clog the domestic financial system. The forex decline since end-March has siphoned out Rs 4,500 crore. (Forex purchases from the Reserve Bank were paid for in rupees). The Reserve Bank raised the cash reserve ratio of banks and sucked out liquidity. The bank rate was hiked, and bank lending interest rates rose in consequence. Y-o-y M3 growth is running 3.4 percentage points behind a year ago. The rupee-dollar exchange rate has stabilised, but the measures to achieve this threaten, somewhere along the line, to hurt economic growth.

The millennium deposits are essential for a roll-back. A couple of billion dollar raisings (sold to the Reserve Bank) would add Rs 9-10,000 crore to liquidity. This could help ease interest rates at the margin. There might be some speculation against the rupee (though, at its current price, the dollar is perhaps not affordable for all imports), but the Reserve Bank could resort to dollar sales from the enlarged kitty.

It is important to bring down interest rates to ease the government's cost of market borrowing. A liquidity expansion would also help the government to complete its borrowing programme. A cautious de-escalation of the cash reserve ratio cannot be ruled out. Domestic policy increasingly relies on foreign savings (albeit from Indians).