It’s true that the market rates of interest are now well off the highs they reached last month, but they’re still very high. For instance, interest rates on three-month commercial paper, which had spiked to 14.9% on 16 October, are down to 13.5%. But that’s the level they were at in early October, so all that RBI’s rate cuts and reductions in the cash reserve ratio have done is to keep rates from going up. Yet, now that the environment has deteriorated so much, what we need is substantially lower rates. The yield on AAA-rated 10-year corporate bonds, admittedly an illiquid market, is at 11%, about 70 basis points off its peak. But it’s still at the levels that prevailed in the beginning of October.

One basis point is one-hundredth of a percentage point.

However, rates on three-month certificates of deposit have come down substantially, from 13.5% in the middle of October to 9.2%. Three-month Mumbai inter-bank offer rate (Mibor), too, has come down from a peak of 12.7% to 11.3%. That seems to suggest that liquidity for banks has eased, but liquidity for companies hasn’t. A cut in the reverse repo rate could make banks lend rather than keep their extra funds with RBI.

Also See: Liquidity Pressure (Graphic)

The tightness in domestic liquidity, of course, is a reflection of the situation in international markets, which have seen a massive flight to safety recently. Money market fund assets in the US have seen a rise of $43.9 billion (Rs2.19 trillion) last week. The stampede to get out of risky assets saw the three-month US treasury yield fall to an astounding 0.01%. The Chicago options index, better known as the VIX or “fear gauge" ended the week at 72, a very high level. Emerging market bond spreads, as measured by the JPMorgan EMBI+ index, shot up to 761 from a spread of 564 basis points over US treasurys on 4 November. Small wonder that EPFR Global, the fund tracking research outfit, says that “Emerging markets equity funds remained under pressure during the third week of November thanks to a toxic combination of slowing economic growth in key export markets, ratings downgrades, high risk aversion and falling commodity prices."

The yen continues to appreciate against the dollar. The credit default swap index for emerging markets, CDX.EM, was at 907 basis points, almost back to the highs reached in October. To cut a long story short, the international credit markets are far from stabilizing. Until that happens, domestic liquidity will remain tight.

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