It’s not that there isn’t adequate liquidity available at present. But as the figures given in the table show, the trend has been towards a lower rate of deposit growth, on the one hand, and a higher rate of credit growth on the other, compared to the corresponding period last year. So the move to cut CRR is essentially a preparation for the future, aimed at ensuring that the green shoots of recovery are not aborted by a premature rise in interest rates.

Liquidity
Consider the quantum of extra liquidity being made available to banks. First there is the one percentage point reduction in CRR. That will release Rs 7,000 crore for banks. Then there is the withdrawal of the incremental CRR of 10 per cent on the increase in liabilities under the FCNR(B), which will augment banks’ lendable resources by another Rs 1,061 crore. But that’s not all. The RBI has also tried to ensure that liquidity remains adequate to take care of the Y2K problem. It has ensured that cash kept in bank vaults will be eligible for CRR purposes. This will have two effects. It will mean that banks will not fight shy of keeping cash in their vaults. That is important, because the demand for cash balances is expected to be increased over the year-end on account of fears about the Y2K problem.

Which means that banks should not have any problems in meeting the cash requirements of the public. For banks, keeping cash locked up in the vault carries a cost. It is a loss in opportunity, in the sense that deploying that cash would have resulted in earning an income. That’s why banks prefer to keep cash in the vault to a bare minimum.

By including cash in the CRR calculation, not only will the public benefit, but banks’ earnings will not be impacted as a result of the requirement of keeping extra cash. The other effect is that the counting of the extra cash for CRR purposes will mean that much more addition to liquidity. In other words, that increase in CRR will release extra funds which can be used for lending.

There is yet another way in which liquidity will increase. This is the RBI’s decision to “improve the cash management of banks” by introducing a lag of two weeks, bringing it on a par with SLR. What used to happen was that the larger state-run banks often had only a hazy idea about the state of their CRR requirements.

The upshot was that they were wary about lending, at least in the first half of the fortnight. This drove up overnight rates, and imparted unnecessary volatility to the call money market. This problem has been pointed out by the RBI in its review, where it says that the spike in call money rates during the first fortnight of October was due to “miscalculation of CRR requirements by some banks and low level of lending by major lenders in the call market.”

Since the large state-run banks are lenders, the change in requirement should translate into extra lending, or more funds being made available to the market. At the very least, volatility will be reduced.

The RBI has therefore taken care of both liquidity and the millennium bug. While the RBI has pointed out that there is adequate liquidity with banks, clearly it believes that growth will result in a tightening of liquidity, and therefore there is a need for a preemptive infusion of funds into the banking system.

Interest rates
By not reducing the bank rate while reducing the CRR, the RBI is giving the signal that the structure of interest rates would not be altered. This is also the signal given by the central bank’s overall stance of monetary policy, which speaks of “provision of reasonable liquidity; stable interest rates with preference for softening...”.

The RBI agrees that lowering interest rates further would harm banks, and it has instead lobbed the ball into the finance ministry’s court by saying that structural impediments stand in the way of lower interest rates.

These impediments are well known: high operating expenses, high NPAs, large government borrowings, and, most importantly, above-market rates of interest being offered by government savings schemes and provident funds.

The preferential rates of tax on mutual funds, leading to a flight of deposits to such funds, has also been cited as a reason why banks cannot afford to lower deposit rates. And they are in no position to lower interest rates on advances without reducing the deposit rates. Apart from liquidity, the other stance of the RBI which comes through is the preference for giving sops for exports through the interest rate mechanism, rather than through a depreciation of the rupee.

An improvement in the external climate has therefore resulted in the removal of the surcharge on import finance, the removal of the minimum rate for overdue export bills.

The restoration of freedom to corporates to cancel and re-book has not been forthcoming. That’s probably because the RBI thinks that “the external outlook continues to be characterised by several uncertainties.”

The RBI has seen that its policy of keeping a tight rein on the forex markets has paid dividends, and it sees no need to rock the boat. So micro management, even to the present level of calling up forex dealers on a regular basis to ascertain their outstanding positions, will continue to be a fact of life.

PLR
So far as reviewing the norms relating to the prime lending rates are concerned, the most important change is that bill discounting by banks will be outside the purview of PLR norms. This will encourage the financing of bills. More importantly, bills drawn on blue chip corporates can now attract a lower interest rate through the bill discounting route. The business of non-bank finance companies, many of which specialise in bill discounting, will be adversely impacted.

Prudential norms
The extension of the coverage of the risk weightage of 2.5 per cent for market risk to all investments could however impact investment in corporate paper. But this is entirely in keeping with the spirit of providing for market risk. It made little sense to set aside capital to cover market risks on government securities, while there was no capital requirement on account of market risk for corporate paper.

Besides, there has been a shift of bank funds away from credit into investments, on account of the greater liquidity of the latter. So imposing prudential norms on investments becomes all the more important.

So far as the exposure to individual corporate borrowers is concerned, the RBI has given a two-year period for bringing down the level of exposure to 20 per cent of capital funds.

That interval should take care of the practical problem of reducing the exposure—after all, no mechanism exists as of now of offloading loans. There is no securitisation. So the only option is to ask the corporate to look for alternative sources of funds, and that could take time when the company is not doing well.

Mutual funds
Shifting the regulatory jurisdiction of MMMFs to Sebi is another step towards making Sebi the sole regulator for the capital markets. With the move towards universal banking, there are a number of grey areas where it will be necessary to decide which regulator is best. The move can also be seen as in keeping with a possible future trend of having a single regulator outside the central bank.

While allowing gilt funds to offer cheque-writing facilities is welcome, the RBI has clarified to a bank recently that cheques can be drawn only in favour of “self”, at least so far as money market funds are concerned.

So what a cheque-writing facility is not people drawing on funds to pay their rent or the neighbourhood grocer, but the facility will actually operate as a kind of account on which one can draw. That is welcome, as it provides an additional element of liquidity to these funds.

Housing and infrastructure
The central bank has tried to remove the impediments to infrastructure financing, by removing the ceiling on the quantum of term loans which can be granted for a single project. The group exposure norm of 50 per cent can also be exceeded by 10 per cent, provided the funding is for infrastructure.

The 1999-2000 budget had attempted to make the housing industry the catalyst for increasing investment demand. The strategy of providing tax concessions for housing finance has worked excellently, leading to a massive increase in housing finance, and a turnaround in the fortunes of the cement industry.

The RBI now takes that process a step further, by treating direct housing loans up to Rs 10 lakh in urban and metropolitan areas as part of priority sector advances.

Moreover, investment in bonds of NHB/Hudco will also be treated as priority sector advances. Banks can now lend for housing in metros rather than take the NPA-ridden road of meeting priority sector targets by actually financing the weaker sections of society. The move is likely to be warmly welcomed by the banks.

Caveat
The review of monetary policy is based on two crucial assumptions. It talks of agricultural production being better than last year, and so inflation is expected to remain under control. The CMIE, on the contrary, has taken the view that agricultural production is expected to decline by 1.5 per cent. If inflation rears its head again, that could put a spoke in the entire money supply expansion strategy.

The second point is that the policy review notes that out of gross borrowings of Rs 84,014 crore budgeted, borrowings up to October 26 amounted to Rs 72,630 crore. But what if the total borrowing requirement goes up to Rs 100,000 crore? The RBI is fully aware of that problem. Hence the remark that “In the management of monetary policy during the second half of the year, a critical factor is the fiscal outlook for the rest of the year.”