India’s economic actions today resembled that of the US today: concerted action to restore confidence in the monetary system. Strange, that the system should have been exposed to be so weak when we supposedly had none of the rot that had permeated the US banking system. Makes one really wonder what went wrong. Maybe we will get to know sometime; at present all one knows is that there is a liquidity crunch, which is being blamed on various factors, ranging from rising credit demand, drying overseas fund markets, FII outflows and whatever else. Such a rapid deterioration, however, comes as a surprise.
The RBI today evening, as announced by the government earlier in the day, has come out with a series of measures. The most important is the CRR cut, by 100bps, after a similar cut earlier in the week, which will release Rs 40,000 crore into the system. The CRR cut is effective October 11 (don’t remember reading earlier when a CRR cut’s effective date was retrospective). So the relief is immediate, one presumes, tomorrow morning banks will have an additional Rs 40,000 crore to flush into the system.
In addition, mutual funds that have been desperate for bank funding to meet redemptions got some relief. Temporarily, banks will be able to take an addition 0.5% of their NDTL (net demand and time liabilities, the denominator of the CRR), to lend to mutual funds. This will salvage the fiasco of the short term repo facility which found no takers. In addition, RBI will also conduct special market operations when the oil companies want to raise funds using their oil bonds.
In addition, banks were due to get money under the agricultural debt waiver scheme. This will be paid to them immediately now, to banks and NABARD. Next, to attract dollar deposits, which will increase inflows, interest rates on NRI deposits have been hiked by 50bps for FCNR (B) and 100bps for NRE accounts. Bank borrowings from their overseas branches and correspondent banks has now been liberalised, they can now borrow upto 50% of their Tier I unimpaired capital or 10mn, higher of the two. Banks with a sizeable overseas presence should benefit from this, ICICI Bank and SBI would be among them.
Earlier in the evening, the finance minister had also announced measures that the government would take. The limit for FII investment in corporate bonds has been doubled from $3bn to $6bn, not sure whether the earlier limit has been breached, but can be seen as a confidence building measure.
In a startling announcement, the FM said that Indian banks are well capitalised, with a capital adequacy of about 10% but the government is now planning to give banks ‘access’ to finance such that their capital adequacy ratio can reach 12% by a suitable date. The details are being worked out. Maybe a few banks are facing some troubles and the government is readying to support them, if the need arises.
Liquidity is one thing, a temporary problem, but capital adequacy is a longer term issue. Capitalisation would mean that the government will be investing in banks, either through debt or equity. The bigger question is will this support be given just to public sector banks or private sector banks too? Are we going to see the government taking stakes in private banks now, that’s a rather scary prospect.