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

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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.

Need for Review of Monetary and Fiscal Policies

EPW Research Foundation At the root of the current chaotic conditions in the financial system in general and the money market in particular are the unplanned borrowings by the government to finance its revenue deficit. The size of domestic saving is simply not enough to finance such large borrowings without starving productive sectors of institutional credit. What is called for is nothing less than a total reappraisal of monetary and fiscal policies.

Interest Rates Reversal of Policy

EPW Research Foundation The policy of treating the money market as the fulcrum of central banking intervention has led to interest rates, which a few months ago had been set to decline so as to aid the growth of the real sectors, having to be pushed up sharply.

Saving Shortage Ominous Portent

EPW Research Foundation Just when there was need for rates of interest on government debt and commercial sector borrowing to be moderated, there is taking place a stiffening of rates. Reflecting the shortage of domestic saving, this will have its impact on both the level of economic activity and the external balance, besides worsening the government's debt burden Policy Events MARCH was marked by several significant announcements the central budget and the government's borrowing programme, guidelines for the enlistment of primary dealers in government securities, the introduction by RBI of the auction system as an additional tool in its armoury of open market operations and one-time relaxation of the requirement of maintaining the daily average CRR for the first 13 days of the reporting fortnight from 85 per cent to 50 per cent for the fortnight beginning April 1. While the steadfast pursuit by the authorities of institution and instrument development in the money market is beginning to have some impact on narrowing the amplitude of fluctuations in money market rates, the process of unwinding from the distortions of earlier policies, including the forced pace of financial sector changes, remains incomplete. The externally-injected liquidity through portfolio inflows created a situation of liquidity abundance, giving an artificial impression of large domestic financial savings when in fact financial savings as well as overall domestic saving ratios have tended to decline. Secondly, there are some signs of disintermediation giving rise to a relatively more severe shortage of resources with banks. Thirdly, of the financial resources diverted in favour of the non-bank intermediates, a relatively higher proportion has been absorbed in secondary capital markets, thus accentuating the shortage of short-term as well as long-term primary capital required for productive sectors. As it is. the commercial banks as well as the UTI are stuck with their asset portfolios which they cannot unwind because of their falling asset prices. Finally, as a result of these factors, just the time when the rates of interest on government debt as well as commercial sector borrowings are required to be moderated, there has arisen a situation of stiffening of the rates. Apart from further deterioration in the government' s debt burden, the impending shortage of domestic savings and the increase in rates of interest may impinge on both the process of economic recovery and the external balance.

Pangs of Readjustment

EPW Research Foundation Pangs of Readjustment The rather painful readjustment of the money market, from a situation of externally-injected excess liquidity to one of liquidity shortage, has been seen in (a) selling pressure on equities, PSU bonds, UTI units and gilt-edged; (b) drying up of the market for such money market instruments as bills and CP; and (c) firming up of interest rates, both shortand long-term.

Inflation Anxieties Cause Liquidity Strain

EPW Research Foundation The monetary authorities anxiety about inflation has led to the current liquidity strain in the money market. (1) GROWING LIQUIDITY STRAIN JANUARY began with the legacy of an unusually tight liquidity regime that dominated the whole of December as a result of several seasonal and non-seasonal factors, such as arresting of the foreign currency accruals and reduced bank deposit growth on the supply side and, on the demand side, advance tax payments. PSU disinvestments, subscription to the UTI's rights offer for US-'64 scheme, and a dramatic spurt in the demand for bank credit to the commercial sector. The legacy persisted: througout January. Again, on the supply side, though the official foreign reserves (other than gold) experienced a small recovery with the RBI re-entering the market for surplus dollar purchases after it withdrew for a quarter or so, the commercial bank deposits have generally stagnated for the second month in succession. Foreign currency assets (including SDRs) increased by only Rs 926 crore in four weeks between December 30, 1994 and January 27, 1995. But the aggregate deposits of scheduled commercial banks, which rose by Rs 1,632 crore during the last week of December, fell by an almost equivalent amount in the week ending January 6 and recovered again by a similar amount in the fortnight ending January 20, thus exhibiting over the four-week period virtual slag- nation. The short-term investible funds available with the public sector financial institutions, which are parked as other deposits' with the RBI and which touched a peak of Rs 3,584 crore on December 23, have remained since then about Rs 1,000 crore below that level up to January 13. On the other hand, demand for bank credit became further buoyant with non-food advances of scheduled commercial banks showing an increase of Rs 3,225 crore between December 30 and January 20. Added to it, from the fortnight beginning January 21, RBI stepped up the cash reserve ratio (CRR) on foreign currency (non-resident) accounts (banks) (FCNR (B)] scheme from 7.5 per cent to 15 per cent and introduced a CRR of 7.5 per cent for the first time on non-resident non- repatriable rupees (NRNR) scheme, which together are expected to impound as much as Rs 1,155 crore of banks' resources. With the termination of exchange cover for the foreign currency non-resident accounts (FCNRA) scheme, a large reduction in deposits under the scheme was accompanied by a corresponding growth in deposits under the above non-resident schemes which hitherto enjoyed zero or concessive CRR. The root cause of the current liquidity strain in the money marketis the RBI's tightfistedness as a result of the authorities' anxiety regarding the persistence of high inflation which, with a 11.1 per cent rise in WPI over the past 12-month period, now stands nearly at double the rate of 6 per cent visualised as a year-end goal, despite a bumper agricultural crop.

RBI s About-Turn

EPW Research Foundation RBI's About-Turn December 1994 ended with the central bank injecting Rs 2,000-2,500 crore into the market to quell the money market's riotous behaviour in an about-turn from the beginning-of-the-month objective of contracting primary liquidity and containing money supply growth.

Over to Open Market Operations

EPW Research Foundation The Reserve Bank's narrow monetarist approach to using open market operations to mop up liquidity will aggravate the government's revenue deficit and raise interest costs for small and medium enterprises precisely when the need was to lower interest costs to revive economic activity.

Travails of a Market in a Hurry

EPW Research Foundation Travails of a Market in a Hurry A The Policy Perspective AN avowed objective of the Reserve Bank of India (RBI) almost since the second half of the 1980s has been to dilute the importance of direct instruments of monetary control such as variation in reserve requirements for banks, regulation of the size and distribution of bank credit and administration of interest rates and to focus instead on indirect instruments, namely, to operate a monetary policy which is based on the level and structure of interest rates that are generally free and market-determined and on the conduct of open market operations in government securities. Initially, the reforms began with imparting some flexibility to the money and government securities markets, for which the recommendations of the two committees, the Committee to Review the Working of the Monetary System (Chairman: Sukhamoy Chakravarty. 1985) and its offshoot, the Working Group on the Money Market (Chairman: N Vaghul, 1987), formed the basis, though the actual changes effected turned out to be different in many respects from those recommendations. Besides, the socio-economic milieu of the period did not permit the RBI to introduce any of the radical changes suggested by the Chakravarty Committee, such as the inflation-linked rates of interest on 91-day treasury bills and 15- year dated government securities and the minimising of the concessional rales for priority, areas. Nevertheless, the measures undertaken during the second half of the 1980s, particularly those concerning money market operations, have had far-reaching significance.

BTW Industries

Vysali Pharmaceuticals Vysali Pharmaceuticals, an existing dividend paying company manufacturing a wide nuige of pharmaceutical formulations, is setting up a bulk drugs plant for the manufacture of semi synthetic penicillins, antibiotics and antibacterials in a phased manner, expecting to earn a reasonable profit working at 10 per cent, 30 per cent and 45 per cent of installed capacity in the first, second and third year of operations. The implementation of the first phase will be completed by September 1992 and the entire project by September 1993, The company expects to exploit the vast potential in the domestic and export market for the complete range of injectibte penicillins and have received enquiries already From Nigeria, Ghana, Zaire, and Abu Dhabi. Promoted by A D Krishnan and Savithry Krishnan, both having had 15 years of experience in pharmaceutical companies, the project in Alwaye village, Ernakulam District, Kerala, will source indigenous machinery and process equipment. The project appraisal has been done by Kerala State Industrial Development Corporation, with its cost estimated at Rs 493 lakh. The public issue of 30,00,000 equity shares of Rs 10 each at par, aggregating Rs 300 lakh, opens on July 6.


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