I write this article in an unimaginable time. In
what ought to have been a festive season with Durga Puja and
Dusshera, Friday 10 October brought to an end probably the most
nightmarish week in the world of business. In a space of just
four trading days, the BSE Sensex has fallen an unbelievable 14
per cent to close at 10,527. From January to now, the index has
dropped by more than 50 per cent. Who knows where it will bottom
out? 9,500? 9,000? 8,500? Or God forbid, less?
The Sensex reflects global mayhem. As I write, the US markets
are yet to open for Friday. Between 1 October and 9 October, the
Dow Jones Industrial has crashed by 20 per cent from 10,831 to
8,579. The FTSE-100 has fallen by 13 per cent over the same
period, from 4,959 to 4,313; and in half a day’s trade on 10
October, the index has already fallen by 7 per cent compared to
the closing price of the day earlier. The Nikkei is down by 27
per cent between 1 October and 10 October. The Hang Seng has
fallen by almost 19 per cent between 2 October and 10 October.
The Singapore Strait Times Index is down by 17 per cent.
There is absolutely no liquidity in the system. Spooked
investors everywhere are unwinding their positions and swiftly
moving to cash. In India, the foreign institutional investors (FIIs)
have acted like lemmings and withdrawn several billions of
dollars in the last few weeks by selling their equity exposures.
But they aren’t the only scared rabbits facing the headlights.
Banks all over, and the Indian ones are no exception, are making
big investments in pillow cases to stuff whatever cash they can
sequester. No wonder, then, that the overnight LIBOR rate has
shot above 6 per cent; and, at home, the inter-bank call money
rate rules between 23 per cent and 19 per cent.
How can we in India deal with this dried out liquidity scenario?
In a sentence, by taking quick, decisive and big ticket actions.
Let me suggest a few — all of which can be done by the Reserve
Bank of India (RBI) with appropriate blessings of the Ministry
Action 1. Cut the cash reserve ratio (CRR), and cut it deep.
Yes, the RBI has finally cut CRR by 150 basis points — up from a
very timid initial move of 50 bps. And it deserves kudos for
this action. However, it isn’t enough to infuse the liquidity
needed to re-inject some degree of comfort in the system.
Consider this. Even up to 13 April 2007, just 18 months ago, the
CRR was 6 per cent. There is absolutely no reason why the CRR
cannot be brought down in another 150 bps cut to 6 per cent. It
will show the RBI’s commitment to making decisive moves — and to
tell the players that it can intervene big when the situation so
Action 2. Cut the repo and reverse repo rate by 200 basis points
to 7 per cent. Do so in one fell swoop, instead of bits and bobs
of 50 bps per time. Again, this will demonstrate proactive
flexibility and the ability to make serious interventions —
something that the RBI needs to do.
Action 3. Rapidly set up a sovereign fund with a corpus of at
least $ 25 billion to support the equity of well run Indian
listed companies and mutual funds. The Life Insurance
Corporation or the State Bank of India can administer the fund,
with trustees and the investment committee being represented by
major public sector financial institutions. As the FIIs sell,
this fund can buy. Given the current price-earning ratios, and
the otherwise good prospects of the better run Group A and Group
B1 corporates, most of these investments will earn solid profits
in a year or two. This was done just a few years ago to save the
Unit Trust of India under Jaswant Singh in the North Block.
Guess what? The investments fetched returns in spades. The
upside of this action is obvious at the current P-E ratios. The
downside side is equally obvious. If nothing is done, soon
enough we will see the FIIs and corporates rapidly accelerate
the process of unwinding their exposure in liquid and money
market funds. Many already have. If this becomes a wave, there
will be massive redemption problems leading to a further
liquidity crisis — something we can ill afford today.
Action 4. This is related to Action 3. The RBI should allow
money market mutual funds to access the repo window. I foresee
significant redemption pressures over the next few weeks as
investors — FIIs and domestics alike — move to cash and fixed
deposits. The RBI needs to relieve this pressure by allowing
money market mutual funds to access money at repo rates.
These actions require two mindset changes. The first is to
recognise that inflation is on the way down. The global meltdown
has knocked off all commodity prices, barring gold and silver;
crude oil prices are down; food prices have abated; and hard
pressed Indian manufacturers are in no position to pass on
higher prices to consumers. We can argue about where inflation
will be at the end of March 2009, or when the election season
gets going. But there can be no argument about its downward
trajectory. Which will continue. Moreover, let there be no fears
that a reversal in monetary policy in these critical times will
again ignite inflation. It won’t.
The second is to appreciate that India will still end up with
7.5 per cent real GDP growth in 2008-09 — the best performance
in today’s world after China. We need to keep this growth going.
That needs liquidity. Nothing saps animal spirits more than
banks not willing to lend at any price. Which is what is
happening. So, we need to understand that these measures are
like injecting adrenaline in a time when extreme steps are
needed to get an otherwise healthy patient from keeling over.
That requires self belief. Let’s collectively hope that the new
RBI governor and the seasoned Finance Minister have this
attribute in abundance. We need it more than ever before.