The Hindu Business Line : Liquidity management

In a swift policy initiative the Finance Ministry has reacted to restrict external commercial borrowings on the lines recommended by the Prime Minster’s Economic Advisory Council and the Reserve Bank of India. Both the chairman of the EAC and the RBI, in its recent monetary policy review, had recommended a series of curbs on inflows to enable the monetary authorities manage liquidity in the system and the exchange rate. The EAC had suggested that an average of $25 bi llion a year as an adequate level for the monetary authorities to manage with an eye on domestic liquidity and inflation. But that cap was breached even in the first quarter, perhaps prompting the Finance Ministry to take action to stem the flow through other means.

Mercifully, the government has not tried to actually block the ECB route in any way although in an earlier policy that was done in the case of funds for integrated townships. Wisely, the government has preferred to use the sluice gates, as it were, to control the flow from ECBs into the domestic economy, and monitor their end use. Thus, ECBs of over $20 million for foreign currency expenditures by any borrower-company for permissible end-uses will have to be parked overseas. ECBs up to $20 million also will have to be parked overseas, even if it is for rupee payments under the automatic route till such time they are actually required in India. In effect, then, the ECB funds either above or below the new limit of $20 million per borrower per year will have to remain overseas with the exception that for actual rupee use in India funds below $20 million can be brought in.

On a surface view, the aim is to enable the RBI manage liquidity better; in the last six months the central bank purchased nearly $26 billion with the consequent impact on liquidity, in turn, prompting the CRR hike. The move to park new ECBs overseas will give the central bank a further boost in its anti-inflation drive. But will it help considering that in the six months to May 2006, other capital flows — portfolio and direct investments — too were surging in? Not likely, but help for the RBI comes from an unexpected quarter. The turmoil caused by the American sub-prime mortgage market meltdown has made portfolio managers jittery. Interest rates are hardening and mid-size borrowers may have difficulty accessing overseas markets. Domestic credit may get a boost as global credit costs rise, especially for greenfield infrastructure projects. In that case, North Block’s gain may just cost the nation dear.