Mumbai: The Reserve Bank of India (RBI) announced a series of measures to increase liquidity in the financial system and stem the fall of the rupee, a day after the Chinese central bank cut interest rates and reserve requirement ratio for smaller banks there amid a continued global markets upheaval.
The most critical part of the RBI package is offering banks additional liquidity support by allowing them to keep 24% of their deposits in government bonds. Although the central bank dubbed it as a “temporary measure” that “will be reviewed on a continuous basis in the evolving liquidity conditions”, the late Tuesday move amounts to a cut in banks’ statutory liquidity ratio (SLR).
Under Indian banking laws, banks are currently required to invest 25% of their deposits in government bonds in the form of SLR. They use the excess investment in such bonds as collateral to get funds from the Indian central bank at 9%. This means that if a bank does not have excess SLR investment, it cannot avail of the RBI fund as it is not in a position to offer collateral. Banks are penalized if their SLR investments go below 25%.
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In a late evening statement, RBI said banks can turn to it for additional liquidity support to the extent of 1% of their deposits and “seek waiver of penal interest”.
“This is a cut in SLR,” affirms A. Prasanna, chief economist at ICICI Securities Primary Dealership Ltd, a firm that buys and sells government bonds.
The overnight call rate that has been hovering between 11.5% and 12.5% in the past few days shot to 16% on Tuesday as the banks do not have excess government bonds to access funds from RBI at 9%.
There are about Rs60,000-70,000 crore of surplus bonds with banks.
RBI has infused on an average more than Rs54,000 crore in past two days into the system, which is tight on account of close to Rs35,000 crore advance tax outflow. Indian companies pay advance corporate tax every quarter. Besides, RBI’s continuous dollar selling, the foreign exchange market is also drying up the rupee liquidity.
The RBI statement said the central bank would continue to sell dollars through banks to augment the supply in the domestic foreign exchange market, or intervene directly to meet any demand-supply gaps.
India’s foreign currency reserves, which stood at $316 billion (Rs14.73 trillion today) in May, have come down to $288.8 billion in the first week of September following RBI’s dollar sales.
The rupee closed at a two-year low of 46.93 on Tuesday, after dropping to 46.99 in intra-day trade. So far this year, it has slipped more than 16%, down 6.5% in September alone. Reuters, quoting foreign exchange dealers, reported that RBI has sold $1.5-2 billion.
Foreign institutional investors, the main driver of Indian equity markets, so far have taken out $8.3 billion from the domestic stock market even as the country’s most tracked equity index, the Bombay Stock Exchange’s Sensex has lost some 33% since January.
To attract foreign currency flows, RBI increased interest by 50 basis points. One basis point is one hundredth of a percentage point.
Banks can now offer foreign currency deposits, or the so-called FCNR(B) deposits interest rates that can be 25 basis points less than Libor or the London interbank offered rate, an international benchmark rate. Till now, the rates were capped at 75 basis points minus Libor. The six-month Libor is at 3.1%. Similarly, the interest rate ceiling on non resident (external) rupee account, or the so-called NR(E)RA, has been raised by 50 basis points.
There has been a net outflow of $403 million from FCNR(B) deposits between April and July, against an inflow of $268 million in the year-ago period. Similarly, NR(E)RA deposits saw an inflow of about $278 million, against an outflow of $565 million during April-July 2007.
“This interest rate measures have been taken to attract forex inflows in the country. The liquidity support is there to reduce the prevailing call money rates as banks are borrowing at a higher rate from the market,” said S. Srinivasan Raghavan, head of treasury, IDBI Gilts.
“This is the resolve by the central bank to control the volatility of the currency and to address the liquidity concerns of the banks,” said R.V.S. Sridhar, senior vice-president at Axis Bank Ltd.
According to Sundara Rajan, chairman, Indian Bank, the increase in foreign currency deposit rates will help banks access cheap funds from the market. “Some banks were accessing call money market for funds, which was high in the last two days,” he said. “RBI wants to come to the market to support them.”