The Hindu Business Line : RBI ascribes cash crunch to frictional liquidity

THE cash crunch in the system is only a case of frictional liquidity and the central bank would intervene if the situation arises. This is the stance RBI has adopted in the quarterly review on the monetary policy.

Dr Y. Venugopal Reddy, Governor, RBI, said that the central bank had adopted a flexible liquidity management system through instruments such as the Liquidity Adjustment Facility (LAF) and the Market Stabilisation Scheme (MSS).

Dr Reddy said that the tightness in the system was on account of frictional liquidity. "So far, it has been a case of frictional liquidity. Our concern is in terms of maintaining underlying liquidity through unwinding in the MSS and open market adjustments in LAF," he said.

Mr Reddy said that reduction of the cash reserve ratio to 3 per cent is a medium term objective and if there are concerns about the underlying liquidity conditions, then the medium term and the current objectives would achieve convergence.

According to the quarterly review of the credit policy, the net addition of liquidity by RBI as on January 20, 2006 was Rs 13,770 crore. During 2005-06 (up to January 18, 2006), the cash balances of the Central Government increased by Rs 11,864 crore. Thus, the total excess liquidity fell to an average level of Rs 94,585 crore in December, 2005 and declined further to Rs 61,317 crore by January 20, 2006. "Redemptions of the order of Rs 10,028 crore are due under the MSS during the remaining part of the current financial year and, if there are no fresh issues, the outstanding balances under the MSS would amount to about Rs 30,000 crore at the end of March, 2006," said the monetary policy statement.

Mr J. Moses Harding, Executive Vice-President, IndusInd Bank, said the monetary measures did not address the tightness in liquidity in the system. "If RBI expects GDP growth to be between 7.5-8 per cent, there will be more demand for credit and further pressure on liquidity."

He added, "The net inflows (inclusive of FII inflows as well as Government expenditure) into the system will not be surplus. Call rates might stay at 6-6.25 per cent and will not be near the reverse-repo rate of 5.50 per cent."

Mr R. V. S. Sridhar, Vice-President, Treasury, UTI Bank, said there would be tightness in liquidity and the situation would improve if Government expenditure entered the system.

The central bank's statement about providing liquidity if the situation arises brought some comfort, said dealers. The chief dealer at a private bank said the liquidity mismatch in the system was temporary and would improve once the Government releases its bunched expenditure, which was withheld till now. "The fact that non-food credit is growing is a clear indication that money is being diverted to various speculative financial activities such as real estate. Hence, hiking the rate was a step in the right direction," said the dealer.