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.