The Hindu Business Line : Sponging out the liquidity

As the forex inflows have remained unabated, bank's stocks of securities are getting exhausted leading to a concern about the possibility of sterilisation of inflows of foreign money. The transfer of government and public sector deposits in commercial banks to the RBI, which has the same effect as the raising of the cash reserve ratio in absorbing liquidity in the system, can be made in phases, depending on conditions of liquidity, says

OPEN market operation (OMO) has become an important instrument in the armoury of the Reserve Bank of India (RBI) in controlling the expansion of the money supply consequent to the massive inflows of foreign exchange in the recent period. Government securities in the possession of the central bank, accumulated over many years of financing fiscal deficit, have been used for repo transactions as also for the regular OMO.

As the forex inflows have remained unabated, the bank's stocks of securities are getting exhausted leading to a concern about the possibility of future sterilisation of inflows of foreign money. The Report of the Working Group on Instruments of Sterilisation, appointed by the RBI, has examined the various options available to the central bank. It has not mentioned one option — the transfer of government and public sector deposits in commercial banks to the RBI. It has the same effect as the raising of the cash reserve ratio (CRR) in absorbing liquidity in the system. However, the recently-released RBI Report on Currency and Finance 2002-03 refers to this though in a somewhat passing manner (para 3.48).

RBI analysts could have examined the available data to find out the scope for the use of the instrument under reference, both in terms of the magnitudes involved and the feasibility of implementation. The bank publishes the results of the annual sample survey of "Composition and Ownership Pattern of Deposits with Scheduled Commercial Banks", conducted by its Department of Statistical Analysis and Computer Services. The latest survey, pertaining to March 2002, was included in the Reserve Bank of India Bulletin of May 2003.

According to Mr A. G. Chandavarkar (Central Banking in Developing Countries, 1996), Article 17(2) of the law governing Germany's Bundesbank provides for the transfer of government funds to and from commercial banks. Canada is another developed country where this has been used widely and successfully. Among the developing countries, Indonesia, Malaysia, Taiwan and Thailand have activated the instrument to sterilise the effects of abnormal capital inflows. Data from the latest published survey on the amounts of Government deposits in banks, as at end-March 2002, are presented in the table.

The total government deposits at Rs 1,18,716 crore constituted 10.6 per cent of all deposits at end-March 2002. Going by past trends and the rise in government deposits from year to year, it would be reasonable to assume that the amount would be around Rs 1,50,000 crore by now. Thus, to take the extreme case, without making any adjustments done normally for computing the CRR, transferring these deposits to the RBI would be the equivalent of raising the ratio by about 10.5 per cent. Of course, one does not expect such a massive transfer either at one time or even over a period. The deposits are intended to facilitate the financial transactions of various government departments in their day-to-day operations all over the country. Some of the money may be in the nature of a float before being credited to government accounts in the RBI. That the date of reference is the end of the month and the financial year should also be borne in mind.

Of the government deposits, the proportion of current account is high for all the sub-sectors ranging from 11.4 per cent in the case of local authorities to 26.6 per cent for quasi-government bodies. The proportion of savings deposits to the total is between 3.6 per cent and 34.1 per cent for the Central and State governments respectively. But what is surprising is the large amount of term deposits. Even the lowest proportion is 44.6 per cent for State governments. For others, it is more than 60 per cent, the highest being 81.7 for the Centre. One does not know the break-up of the term deposits by their duration. If they are for short periods, for 15 days to a month pending disbursement, the departments should be congratulated for wise deployment of funds. But one cannot be always sure on such matters. Considering that the governments, either at the Centre or the States, are most of the time in deficit with occasional seasonal deviations from the pattern, there should be a detailed look into the origin and duration of term deposits. A considerable proportion of the funds is borrowed money with interest rates higher than deposit rates. Second, though funds are fungible, one can argue that banks are making profits by using government's own money to invest in its gilt-edged securities — a case of round tripping.

Today, perhaps with a few exceptions, all the departments of the Central or State governments in State capitals have the facility to operate their financial transactions through the RBI directly. To begin with, the Centre and the RBI can examine the feasibility of transferring the former's bank deposits in metropolitan areas to the latter in a phased manner. An amount of Rs 15,884 crore, or more than three-fourths of the Centre's deposits, was in metropolitan areas, according to the RBI survey. One can reasonably assume that a major proportion would be in Delhi and Mumbai, where a start can be made. Instead of issuing a cheque on a commercial bank, the paying authorities have to use an RBI cheque. It does not, prima facie, appear to be beset with any practical problem. The transfer may be made in phases, depending on conditions of liquidity and trends in the money market.

Going by the data the transfer would amount to raising the CRR by about 1.5 per cent, not a small number from the point of view of money supply or banks. The one snag is that the funds in savings and term accounts, which earn interest from commercial banks, will lose it if they are shifted to the RBI. But, then, the Government should think of the benefits. It need not pay charges for the current account. But, more important, it does not have to pay interest on that portion of government securities in which its bank deposits are now invested. An exception may have to be made for accounts such as those of trust and provident funds which depend on interest income.

It is not as if all such bank accounts should be closed and transferred to the RBI. The existing accounts may be maintained with low balances, wherever possible, for the following reason; exceptions for larger balances could be considered on merits. The transfer of deposits need not be a one-way or a one-time operation.

When the banking system is short of funds, government deposits can be re-transferred from the RBI to it. Mr Chandavarkar refers to the successful experience of the Malaysian central bank in auctioning government deposits among banks.

The transfer mechanism is on a par with CRR in terms of merits and demerits in impacting the money supply. The additional advantage is that, unlike in the case of CRR hikes, no one can call it a tax on the banking system. The Government may think of appointing an expert group to examine the matter.

(The author is a former officer-in-charge of the Department of Economic Analysis and Policy, Reserve Bank of India.)

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