The Hindu Business Line : Foreign currency assets at record high

Between April 1 and December 8, the FCA increase has been to the tune of $23.29 billion, which is higher than the $23.03 billion during the same period of 2003-04. What is more, in 2003-04, the build-up was partly on account of a weak dollar, which inflated the (dollar-denominated) value of non-dollar currencies in the Reserve Bank of India's (RBI) forex chest.

All-time-high

There has been no such artificial weak-dollar impact this time, which makes the FCA increase more `real'. An indicator of this is the rise in FCA in rupee terms, where the difference between 2006-07 and 2003-04 is even more marked compared to the dollar-to-dollar numbers (see Table).

The all-time-high FCA accretion this fiscal has sent the RBI into a tizzy, just as it did in 2003-04. The huge surge in forex inflows has forced the central bank to mop up the excess dollars and, in turn, has led to the release of base rupee liquidity or Reserve Money. To counter this, it has then had to contract lending to the Government and banks.

But in spite of all this, reserve money expansion so far in 2006-07 has been the highest ever, causing a liquidity overhang.

Further, while in 2003-04, the surplus liquidity in the system was in an overall recessionary environment, this time factories are running to near-full capacity.

Moreover, there is a pressure on supply of essential food articles, unlike the overflowing foodgrain stocks and easy global availability of edible oils or pulses in the past.

To add to these are seemingly genuine fears of an overheated property market and asset price inflation. A textbook case, indeed, of too much money chasing fewer goods and assets.

Small wonder then, the RBI has chosen to go beyond normal liquidity mop-up measures such as hikes in the repo and bank rates or issuing fresh securities under the market stabilisation scheme.

On December 8, it instead straightaway announced a 50 basis point increase in the cash reserve ratio (CRR) or the proportion of deposits that banks are required to compulsorily park with RBI.

The CRR hike, apart from directly impounding some Rs 13,500 crore of bank deposits, will also dampen credit expansion and broad money growth by lowering the `money multiplier'.