Bigger fund stimulus may come banks’ way

Liquidity Taps Continue To Be Turned On Full Blast, With Govt Weighing Transfer Of Market Stabilisation Scheme Money To Its Accounts. But Consumers & Corporates Have Little To Cheer As More Wrinkles Emerge...

IN WHAT could prove to be a bigger liquidity boost than the 2.5% cut in the cash reserve ratio (CRR), the government is considering converting funds impounded under the market stabilisation scheme (MSS) into regular government borrowing. The move will free up funds with banks for lending to borrowers which they otherwise have to lend to the government.
    MSS was introduced by way of an agreement between the government and the Reserve Bank of India (RBI) in early 2004. Under the scheme, RBI issues bonds on behalf of the government and the money raised under bonds is impounded in a separate account with RBI. However, the money does not go into the government account.
    As on October 22, the balance under MSS stood at Rs 1,71,317 crore. Now, the proposal is that the money lying idle in the MSS account be transferred to the government account and be used for revenue and capital expenditure. Such a move, bankers say, will reduce volatility in the money market, as banks will now be free to use funds to lend to consumers and business. Otherwise, the fund would have been invested in bonds issued by the government to meet its borrowing requirements.
    Because of the tightness in the money market, the government has postponed its borrowing. Since borrowing peaks in the last quarter, backending of the borrowing programme will put pressure on interest rates.
    The government will complete its budgeted borrowing by December 2008. But a large chunk of borrowing is expected in the fourth quarter because of supplementary grants. While conversion of MSS will provide the government with low-cost financing without disrupting the markets, it would not immediately bring in liquidity. Banks are worried over the hardening of rates and fear that further intervention by RBI would result in cash shortage.
    Another move that could be considered by the government for reducing volatility in the markets is to allow banks access funds against pledge of securities that are part of the statutory liquidity ratio (SLR) requirement.
    According to HDFC Bank head of interest trading Ashish Vaidya, RBI could consider allowing banks access to additional funds against their SLR securities. "To ensure that money does not move from good assets to bad assets there could be certain conditions. For instance, one condition could be that the credit growth of the borrowing bank should not be out of sync with the system," he said. Mr Vaidya points out that this would achieve the goal of stability in the markets and protect banks against any liquidity crunch.
    The other major demand from banks that is being considered is direct lending in foreign exchange by RBI to banks. At present there is intense demand for dollars because of sales by foreign institutional investors. Some banks are also buying dollars here to support their overseas operations, which is adding to the pressure. The central bank has been meeting the shortfall by selling chunks of its foreign exchange reserves. Banks now want RBI to sell them dollars directly as this would reduce pressure on the rupee and consequently reduce the need for the central bank to intervene in the forex market and reduce rupee liquidity in the bargain.