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P. Devarajan

"International liabilities of banks are now nearly double of their international assets which is an issue of serious concern," says a RBI report.

IN just over a fortnight from now, on July 26, the Reserve Bank of India will unroll its First Quarter Review. The experiment spelt out in the April 28, 2005 Annual Policy said the Review "should provide the opportunity for structured communication with markets on a more frequent basis while retaining the flexibility to take specific measures as the evolving circumstances warrant."

On April 28, the RBI marked up the fixed reverse repo rate (the interest banks earn on free funds parked with the RBI against government paper) by 25 basis points under the Liquidity Adjustment Facility (LAF) to 5 per cent from 4.75 per cent. Since then, the financial markets have been a tad quiet with the recent Rs 10,000-crore auction of government paper going through easily.

Traders are not prepared to take a bet on a trend in interest rates as the amount under reverse repo has dropped from around Rs 18,000 crore on July 5 to Rs 5,800 crore on July 8. The MSS should have at least Rs 50,000 crore which the RBI can unwind to lift liquidity.

Quite a few players think the RBI may not tinker with key variables; but none is sure. The RBI would not like the rupee to sharply appreciate against the dollar and also will keep a tab on the volume of rupee funds triggering any possible inflation. Sectoral policy liberalisations (however slow-paced) in the coming months will only add to dollar inflows and at this point of time, it is hard to think of a surge in dollar outflows.

The critical variable is crude oil prices and the Centre cannot for long continue to bleed oil companies to hold price levels as at some point banks may turn uncomfortable funding them. A mark-up in retail prices of refinery products will have to come if crude continues to stay on the wrong side of $60 per barrel. The crude price impact can be tempered by a good monsoon and bumper kharif and rabi crops, but that is for the future.

Some of the well-performing corporates seem to have delinked themselves from the banking system by opting for cheap overseas funds, apart from sitting on their own cash piles.

An indication comes from the anonymous (the report is unsigned) Report of the Internal Technical Group on Forex Markets from the RBI.

The Report says: "One of the shortcomings of the Indian foreign exchange market is that the forward price of the rupee is not determined by the interest rate differentials alone but is influenced in a major way by a) supply of and demand for forward dollars; b) interest rate differentials and expectations of future interest rates and c) expectations of future US$/INR rate."

This would indeed be the case in all countries that still have exchange and capital controls. To initiate the process of integration between the two markets, the RBI has permitted limited access to banks to borrow from and invest in the overseas markets.

Presently banks are permitted to borrow overseas up to 25 per cent of their Tier 1 capital or $10 million, whichever is higher. However, overseas borrowings of banks for funding export credit are not included in this limit.

In March 2004, rationalisation of the various avenues for foreign currency borrowings of banks was undertaken and a system of monthly reporting was introduced.

Current data indicate that the banking system's overseas borrowing is quite close to the overall ceiling and if borrowings for funding of export credit are also included, the total overseas borrowings are significantly higher.

A reference is also drawn to the Report of the Internal Group on External Liabilities of Scheduled Commercial Banks of the RBI, dated May 24, 2004, which says "international liabilities of banks are now nearly double of their international assets which is an issue of serious concern."

In this context, will the RBI ease limits on overseas borrowings by banks to fund foreign acquisitions by Indian corporates?

With the best corporates off their books, banks will have to willy-nilly finance farmers and SMEs to garner profits.

It may not be the best time for the RBI or the Finance Ministry to signal a high interest regime given the reluctance of the banking system to touch farmers and SMEs.

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