ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Distortions Come to the Surface

EPW Research Foundation Distortions Come to the Surface Macro Perspective CAUGHT in the shocks of adjustment to a situation of liberalisation, the financial system, contrary to official expectations, has plunged into a quandary. Many distortions associated with a free-for-all environment have come to the surface. First, within a short period of a year or two the economy has swung to the extremes, from an abundance of liquidity to an acute shortage of liquidity and now back to an easy situation. Underlying these swings has been the dependence of the financial system on the injection of liquidity from outside, even as the natural growth of financial savings has remained stunted. The blocks of assets externally injected in spurts are gobbled up by the pent-up demand for funds by the private sector and the government alike. Secondly, the apparent consequence of sw ings in liquidity is seen in increased uncertainty for both the purveyors of institutional credit and productive enterprises seeking credit. Banks seem to have become extremely loan wary, thus seeking more solace in risk-free sovereign instruments. A third and final distortion is to be seen in the structure of interest rates. While immediate liquidity considerations are tending to push short-term rates downwards, the rates for bank loans and loans of term-lending institutions have remained high and sticky as a result of the high-cost funds mobilised by banks as well as the FIs.

Easing of Liquidity Is it Real

EPW Research Foundation Easing of Liquidity: Is it Real? A close look at the factors responsible for the easing of the long spell of illiquidity in the money market brings out very clearly that they can provide only a short-term respite.

Low Savings, High Demand for Funds

EPW Research Foundation Low Savings, High Demand for Funds Liquidity Strain: Experience THE financial year just concluded has faced certain unusual features in regard to the tight liquidity situation. The high growth of bank deposits and other financial instruments in 1993-94 and 1994-95 in the wake of sizeable foreign currency inflows gave way to sluggish growth in 1995-96 as these inflows were arrested. Domestic savings appear to have been unequal to the high level of demand forfunds from the government and corporates alike stimulated by earlier liquidity inflows. As against the targeted Rs 65,000 crore (17 per cent growth), aggregate bank deposit accruals are likely tobealittleoverRs 50,500 crore (13.1 per cent). Funds mobilised by mutual funds during the year are estimated to be about 58 per cent lower than in the previous year (Table 1). On the demand side, apart from the sizeable market borrowing requirements of the government and intensified needs of the corporate sector, a major factor that has put tremendous pressure on liquidity has been the demand placed on the market in the form of primary issues of bonds and equities by banks and financial institutions (Fls), essentially for satisfying, particularly in the case of banks, their capital adequacy norms, A tentative compilation suggests that the banks and FIs raised nearly Rs 9,000 crore in 1995-96. Besides reducing the availability of funds for the government and the corporate sector, such demands by the purveyors of credit themselves have given rise to unpreccdentedly high levels of interest rates.

Growing Inter-Linkages between Markets

EPW Research Foundation Growing Inter-Linkages between Markets There was a sudden revival of FIIs' interest in the stock market and portfolio inflows rose, the rupee which had dipped to the lowest level in early February began to strengthen and as this happened the market players scrambled for counterpart rupee funds to benefit from the available arbitraging opportunity between not only the domestic money market and the foreign exchange market but also between the spot and forward segments of the foreign exchange market.

High Interest Cost Weighs Down Corporate Performance

EPW Research Foundation While there are signs of the liquidity situation easing the result of continuous primary injection and its secondary impact the financial markets and the productive sectors are gearing themselves up to cope with a high interest cost economy.

Coping with the Liquidity Crunch

EPW Research Foundation Coping with the Liquidity Crunch Illiquid Scenario THE situation of severe liquidity shortage is getting reflected in the market players resorting to variousdevices to cope with it. Asexplained in Section II, the slump in the stock markets and the general illiquid scenario have shitted locus from equity to debt instruments hut this has also been accompanied by an unusually high rise in cost of funds. While banks have focused on raising funds through certificates of deposits (CDs) and bonds with such aggressive rates of interest as 16.5-21.0 per cent, financial institutions have sought to raise resources through bond issues at 16 per cent or over, apart from raising them also from foreign markets through floating rate notes (FR Ns) and foreign currency convertible bonds (FCCBs). A host of PS Us are slated to hit the bond market in the early months of 1996 Private corporate* are, however, finding it difficult to raise funds through domestic bonds, and hence are turning to the foreign markets based on the revised guidelines. Increases in prime lending rates by banks and financial institutions, substantial reductions in disbursements by the latter and also in loans by finance companies, corporates' plea lo rollover their loans and interest payments, and even defaults on their letters of credit (LC) commitments, are some of the other devices and repercussions - seen in coping with the liquidily constraints.

Linked Markets, Unlinked Policies

EPW Research Foundation Linked Markets, Unlinked Policies The last two months' developments in the foreign exchange and money markets have thrown into sharp relief the close linkages developing between the two markets. While the Reserve Bank managed 10 stabilise the spot foreign exchange market by injecting the equivalent of $ I billion in October, the impact of its intervention was felt in the extreme stringency in the money market as reflected in the shooting up of call money rates which, in turn, led to a speculative surge in the forward premia on the dollar.

Liquidity Strain to the Fore

EPW Research Foundation Developments in the foreign exchange market led money market movements in October, aggravating the liquidity strain in evidence since the beginning of the financial year.

Gap in Busy Season Credit Policy

EPW Research Foundation Gap in Busy Season Credit Policy The resource position of banks in the coming months is likely to be very tight a prospect which has been hardly addressed by the busy season credit policy. This has formidable implications for the money, credit and debt markets in the second half of the financial year.

RBI to Government s Rescue

EPW Research Foundation RBI to Government s Rescue The government's avowed objective of keeping the monetised deficit under check notwithstanding, the market's lukewarm response to its borrowing programme has pushed it into overwhelming dependence on the RBI. Phenomenal levels of monetised dificit have been the result.

Fiscal Deficit Return to Original Sin

EPW Research Foundation Fiscal Deficit: Return to Original Sin Emerging Easiness in Liquidity THE severe liquidity strain, experienced by the money markets in India during the first quarter of the current fiscal year, continued until the first half of July and has suddenly given way to some easiness during the latter half of the month. Apart from the seasonal factors of supply of and demand for banks' resources, the emergence of underlying signs of slackness in demand for bank credit due to some possible slow-down in industrial investment and output activity is probably reflected in the current trends. To an extent, the massive year-end bulge in banks' balance sheets as of March 31 and the subsequent unwinding make it difficult to get a clearer view of the liquidity situation from the available banking data for the early months of the year. As the size of the year-end buildup of banks' deposits and advances, arising from interest crediting, draw-down of public sector funds towards the fag end of the year and window-dressing, has been growing year-by-year, the process of unwinding has also been increasingly getting prolonged. Last year by July 22, the declining trend in aggregate deposits from the March 31,1994 bulge had stopped; there was in fact a rise of Rs 1,486 crore by then. On the other hand, this year the aggregate deposits at Rs 380,160 crore continue to remain lower than the level of March 31, 1995 by as much as Rs 6,699 crore. Such a large swing in banking trends cannot be entirely explained by the last year's foreign exchange accruals and the consequential increase in bank deposits - a phenomenon which has been generally absent this year.

A Dearth of Ideas

EPW Research Foundation A Dearth of Ideas While the acute shortage of liquidity combined with an unrealistic government borrowing programme has imparted a great deal of uncertainty, the money market also seems to perceive that the rates of interest on government debt have now peaked. The result is an inversion of the yield curve for government securities.


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