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The Need for Rapid and Decisive Action

Omkar Goswami


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 In India, the foreign institutional investors (FIIs) have acted like lemmings and withdrawn several billions of dollars in the last few weeks by selling their equity exposures.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 of Finance.

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 demands.

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.


Published: Economic Times, October 2008


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