In recent weeks, companies which are short of cash have withdrawn money from mutual funds where their treasury function was often outsourced. These redemptions led to sale of bonds by mutual funds. Given the illiquidity of the bond market, bond prices had dropped sharply as a consequence of this sale of bonds by mutual funds. Real estate companies and NBFCs, which are prohibited from accessing funding in most parts of Indian finance, were particularly affected since mutual funds are a key source of funding for them.

In an important move, RBI set up a mechanism for mutual funds to obtain liquidity support of Rs 20,000 crore. This reduces the disruption suffered by mutual funds, real estate companies and NBFCs. In the long run, India needs a well-functioning bond-currency-derivatives nexus, with a deep and liquid bond market where bonds can be easily sold. In coming months, the recommendations of the Patil, Mistry and Rajan reports must be implemented, so as to achieve this system of markets. In the short run, RBI has done well to recognise this element of the financial crisis and directly address it. Call money rates fell to 10 per cent from 20 on October 10 following RBI’s liquidity moves. The rate is, however, still above the LAF corridor, indicating that liquidity will remain a concern.

On the stock market, Nifty rose by only 0.8 per cent — a weak gain, given the optimism in world markets. While the rupee-dollar rate appreciated marginally to 47.71, the currency futures trading at NSE ended with a forecasted rate of Rs 48.23 for October 27.

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