Growth afloat on RBI's new life buoys

NEW DELHI: The Reserve Bank of India (RBI) and the government are working on new ways to control liquidity in the face of relentless forex inflows without only relying on instruments such as the cash reserve ratio (CRR). In its latest currency and finance report, released last week, RBI said there is a need to explore further instruments or options for liquidity management, particularly in the context of a move towards fuller capital account convertibility.

“The government and RBI are looking at new options to counter liquidity,” a source in the finance ministry said. RBI would prefer using a ‘series of approaches with existing instruments’ without shutting off any one option completely, the source said.

“RBI has several options to consider and it can use a combination of measures to tackle forex inflows and liquidity. These include diversifying a part of its foreign assets into non-sovereign assets like China has done, increasing substantially the incremental CRR, go for a freer float of the rupee or even look at a disguised Tobin Tax to discourage the inflow of short-term hot money,” Aditya Birla Group chief economist Ajit Ranade said. Tobin Tax is a levy on currency trades across borders to discourage short-term speculation in currencies.

Last month, China’s new state investment agency invested $3 billion of its forex assets in US private equity firm The Blackstone Group. “Since these are unusual times, such unusual options can be looked at,” one analyst said. But such a proposal is fraught with risk since sovereign funds parked in such vehicles would expose RBI not only to currency risks but also to equity risk. The list of entities that RBI can invest in can be expanded to accommodate not just sovereign debt but triple-A securities, he added.

RBI can look at hiking CRR on incremental flows, rather than total deposits, as suggested by SS Tarapore, chairman of the committee on fuller capital account convertibility. Incremental CRR prescribes a reserve ratio based on the extent of growth in deposits. The impact of this is in stemming excess liquidity in banks showing high growth without penalising the entire system.

While commercial banks are not required to currently maintain incremental CRR, in the past they were required to maintain a 10% incremental CRR on non-resident deposits to reduce the liquidity created by flow of funds from NRIs. The option of using dollar swaps to manage liquidity becomes limited as the rupee gains strength.

“RBI will not close the CRR option. It will look at augmenting its existing instruments to tackle inflows and liquidity. For example, a slew of auctions will be conducted this week. This normally does not happen often,” a source said.

“It is only six months into the year and the market stabilisation scheme (MSS) cap is close to the ceiling of Rs 1.1 lakh crore with over Rs 80,000 crore already issued under this window. MSS cannot be issued indefinitely,” an expert said. Some analysts are of the view that it is cheaper to increase CRR than to issue MSS bonds.

“It also cannot fight the deluge of forex inflows by without revisiting the cap on MSS because the increased cost of sterilisation must be shouldered by the government as well. This cost is, in fact, an insurance toward currency stability and buying investor confidence,” Mr Ranade aid. By RBI’s own admission, the nature of flows is becoming difficult to ascertain.

Besides, with a 60% appreciation in the ECB limit from $14 billion to $22 billion in a single year, it significantly contributed to forex inflows, an analyst pointed out.

“Whatever the options are, the time is now ripe for RBI to experiment, given that inflation is under control at 4.68%,” an analyst summed up.