Liquidity woes to drive RBI to cut CRR, bond purchase

Managing liquidity will be key for RBI as liquidity will progressively deteriorate, says Hitendra Dave, head of global markets India, HSBC Bank. In an interview with Aparna Iyer, Dave says inflation level doesn't allow RBI to cut policy rates but the liquidity problem will prompt them to continue with CRR cuts and open market bond purchases. Excerpts

Do you expect RBI to cut rates in late October?

Rate cut depends on whether RBI wants to boost animal spirits of the economy, reinforce stock market sentiment or does it want to see through its stated objective of lowering inflation to levels which are compatible with the long-term goal.

If the intention of the policy is to lower inflation to 5%, there is no way you can justify a cut. The economic case for rate cut is very weak. The only case is that the government has taken a lot of steps and RBI should support. That is a judgement for the governor to make. I think the impact of a rate cut per se is overestimated.

Do you think RBI will cut CRR considering it is at nine-year low?

RBI now has an official stance on liquidity which is that liqudity will not be allowed to go outside the 1% of NDTL. Whenever that happens, we know RBI will step in. There is nothing wrong in CRR going below 4.5%.

Liquidity in terms of money creation comes entirely from capital flows. But our system loses liquidity every six months through the informal economy and due to general preference for cash. The amount of liquidity that leaves the system is around R8,000-10,000 crore a month and is growing.

That means every six months, the system needs 1% CRR cut or an equal of OMO bonds buys or a combination to avoid disruptions. Liquidity is only going to deteriorate now progressively right up to March. Therefore, the choice is between OMO and CRR or both. Or they can buy dollars.

... contd.

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