MUMBAI: The time for Indian companies to pay tax is near, and that could mean accentuated cash tightness which pushes up overnight interest rates and spurs the Reserve Bank of India to cut banks' cash reserve ratio in March.
The last cut in the ratio (CRR) was in January, by 50 basis points to 5.5 per cent.
Overnight inter-bank rates rising to close to double digits and banks dipping into a special liquidity window to borrow at higher rates for a week or two would be decisive factors that could prompt RBI to cut the CRR again, four RBI officials said.
A CRR cut might still leave the cash deficit – the shortfall among banks to fund their loan book -- above the RBI's comfort level. However, central bank officials won't lose sleep as long as systemic interest rates remain stable, the officials said.
India is experiencing a bout of cash tightness that started in mid-November. The call rate has mostly remained close to the repo rate of 8.50 per cent, except for a few days in January, and that's key reason for the RBI to not step up its liquidity infusion steps.
The cash deficit is currently around 1.6 trillion rupees. Banks expect it to rise to 2 trillion rupees in mid-March, with the bulk of the increase stemming from companies pulling cash from banks to make tax payments.
The RBI prefers to maintain a cash deficit position, for making monetary policy effective. It has said its comfort zone for the deficit is around 600 billion rupees.
Still, the current, severe credit crunch -- which has kept the deficit more than double 600 billion rupees -- has not made overnight rates shoot up, mainly because of the availability of funds from the RBI's repo borrowing window, the officials said.
“The comfort zone is only an indicative one,” said a senior RBI official. “We don't need to get unduly disturbed as long as call rates do not shoot up, government bond yields and auctions do not show signs of stress.”
KEEPING A CLOSE EYEThe central bank keeps a close eye on the inter-bank overnight rate market as it considers this to correctly reflect its liquidity management stance.
Dealers expect the call rate to rise to 9.5-10.0 per cent from 8.5-9.0 per cent now, and banks to tap the special liquidity window, called the marginal standing facility, to deal with cash outflows for tax. If they do, this will signal stress to the RBI.
Though the overnight rates have not moved much, short-term rates on other instruments such as bulk deposits or certificates of deposit, overnight indexed swaps, Treasury bills have gone up.
The three-month certificate of deposit rate rose to 10.20 per cent from nine per cent in mid-December while the one-year swap rose by nearly 40 basis points to 8.07 per cent and three-month T-bill rate was 8.94 per cent, up from 8.49 per cent.
Currently, the central bank has only two options to channel primary liquidity into the system -- putting more cash with banks by purchasing some of their government bond holdings through open market operations (OMO), or cutting the CRR.
“We can address the permanent shortfall through OMOs and CRR cuts. But these steps will only help in neutralising a part of the incremental shortfall in liquidity and not the entire shortfall,” said a senior RBI official.
CASH CRUNCH BEGAN IN NOVEMBERRBI officials admit that the central bank should have anticipated the cash crunch that began in November, and started injecting liquidity before then.
Another option -- buying dollars in the spot market – can also help in easing the tight cash conditions. But the RBI is very clear in its exchange rate policy: it won't use intervention in the forex market as a tool to manage liquidity.
RBI Deputy Governor Subir Gokarn said on Feb. 8 that exchange rate volatility, and not liquidity, will be the prime driver for forex intervention.
Last month, a senior RBI official told Reuters the central bank may resort to intervention in the forwards forex market in addition to spot, so that the impact on liquidity is shifted to a later date.
The RBI has been selling dollars consistently since September to bolster a weakening currency, which added to the cash tightness.
Many factors are responsible for India's sustained liquidity deficit. Among them are inadequate government spending, seasonal currency withdrawals by the public from banks, high reserve requirements which mean banks cannot lend out a chunk of their growing deposits and the RBI's forex intervention to support a weak rupee.
The liquidity shortfall started to shoot well past the RBI's comfort zone from mid-November when banks' borrowings from the central bank under what's called the liquidity adjustment facility (LAF) averaged one trillion rupees daily.