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Cashing In (And Out)
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Schickler may find his India experience useful, given the tight liquidity conditions in the inter-bank money market that have prevailed in this country since July 2010; true, there has been some relaxation in the tightness in the first week of April, thanks to the effects of a burst of government spending in March; before you rejoice, however, remember that this liquidity infusion is usual for this time of year.
Most experts have concluded that this respite will be brief; the structural tightness in the money market — slower deposit growth relative to credit growth, and lower capital inflows compared to previous years — is expected to persist at least through the first half of 2011-12 (FY12). For most of FY11, deposit growth has been sluggish, at 16.7 per cent, while credit growth has been 23.2 per cent, a gap of almost 8 per cent. Deposit rate hikes in the last quarter may have helped somewhat; in the January-March quarter, the gap narrowed to about 5.5 per cent or so. Most bank CEOs in past weeks have said that they do not envisage raising deposit rates further in the immediate future, so will this gap plateau out?
Not many want to venture a guess, so what will liquidity be like in the next three months? One space to look is the growth in reserve money: currency in circulation plus banks' deposits with the Reserve Bank of India (RBI) and net foreign assets (broadly, our foreign exchange reserves) held by the RBI.
As we all know, capital inflows have not been extraordinary, so foreign sources will not be a big driver of liquidity. On the other hand, currency in circulation — or the cash in all our wallets — has been a larger component in recent times than it has been in past years. More currency in circulation, less deposits in banks.
That's because of food inflation. Since most of us buy food with cash, we keep a greater share of our discretionary expenditure in the most liquid form. Given the latest food inflation numbers, it is clear that food prices are highly resistant to moderation for a plethora of reasons. So the outlook for banking system liquidity looks a little grim. The RBI could help ease the liquidity constraints, of course; but the central bank has a much bigger problem on its hands: bringing down inflation as quickly as it can. Recently, the RBI announced its new operating framework for the conduct of monetary policy. A quick review of the various elements of that framework suggests that the RBI would prefer to keep liquidity on a tight leash.
What the framework does is to reduce the uncertainties that may have plagued the current framework (the new one will become operational during this financial year). While liquidity may be tight, it won't be subject to the volatile swings we have seen in the past; interest rates in the overnight inter-bank call money market will not oscillate as much as they used to.
The message — and indeed the outlook for the next six months — seems very clear: banks will have to manage their asset liability equations more actively. Perhaps it is time for banks to think of putting in place their versions of Thomas Schlicker. And the quicker they do it, the better.
(This story was published in Businessworld Issue Dated 18-04-2011)