'Don't stash the cash; put it in money mkts'
The government should not hold on to idle cash, but rather invest it in the money market to earn better returns and curb volatility in interest rates, feels RBI, reports Our Bureau.
By TNN |
MUMBAI: The government should not hold on to idle cash, but rather invest it in the money market to earn better returns and curb volatility in interest rates, feels RBI, reports Our Bureau.
The suggestion comes after money markets witnessed a liquidity crunch in the second half of `05-06 when the government sat on large cash surpluses, thereby impounding money and causing interest rates to rise.
“During ’05-06, the build-up and volatility in central government’s cash surplus with RBI had a significant impact on liquidity conditions in India,” RBI said in its annual report. The central bank has pointed out that cash balances, when maintained with the central bank, do not form part of the liquidity in the banking system.
Therefore, sharp increase in surplus balances in the government’s account reduces liquidity in the banking system and this could drive up the short-term interest rates.
The central bank has pointed out that in many countries with developed financial markets, the government lends surplus funds to the banking system.
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The US allocates its balances to market participants on a pro-rata basis at a fixed reference rate of interest (currently 25 bps below the Fed funds rate), while France and the UK deal directly with market participants. The US requires full collateral for its cash balances while France and the UK invest mainly through the repo market.Pointing out that most of these countries rely on their central banks to manage surpluses, RBI said that their experience could be used to develop an appropriate cash management strategy for the Indian government.
It has said that arrangements, which facilitate transfer of surplus funds from the government’s account to deficit participants in the system, could help in better management of liquidity in the system.
Such arrangements not only enable the government to earn better returns on the cash balances, but also mitigate volatility in short-term interest rates and keep overnight money market rates stable.
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