The Hindu Business Line : Hopeful injection

Central banks around the world are toying with interest rate cuts to prevent economies from sliding into recession, and the RBI could do worse than follow that lead.

The Securities and Exchange Board of India and the Reserve Bank of India have eased some of their own restrictions in what may appear to be quick policy responses to the ongoing credit crisis in the West that has squeezed the liquidity in both the equity market and banks in this country. While SEBI removed the caps on issue of Participatory Notes (PNs) imposed in October 2007, the RBI reduced the cash reserve ratio by half a percentage point, to 8.5 per cent. Such moves co me on the heels of the Finance Ministry’s relaxation of ECB ceilings for infrastructure companies late last month, all motivated by the urge to compensate for the rapid outflow of capital consequent to the engulfing credit crisis and the collapse of investment banks last month.

Exactly for that reason however, the initiatives may not quite evoke the desired response simply because across the world liquidity seems to have dried up right now and till such time as western banks recapitalise, the rest of the world will have to rely on its own devices. That is why some Asian central banks quickly followed their Western counterparts in injecting liquidity into their respective economies, accompanied by softer interest rate agendas to ward off a recessionary contagion. It is hardly surprising then that the Sensex fell again on Tuesday after an initial enthusiastic bounce.

The RBI move will release Rs 20,000 crore into the system. Of course, it will not help the equity market that has relied heavily on a consistent flow of FII money the last three years. However, if banks have more cash to lend, theoretically that could mean more credit and, therefore, a boost for the economy. But that possibility too seems dim, given the high interest rates that have led to a dip in demand for key consumer items; four-wheeler automobile sales, for, instance and real estate through August and September. In turn, high interest rates and falling consumer demand are forcing output cutbacks, as industrial data trends indicate. The RBI states that it can reverse its stance but events may prove that caution unnecessary, perhaps harmful. Oil prices have fallen far below $100 a barrel, commodity prices have followed and inflation has eased below 12 per cent after three months. Central banks around the world are toying with interest rate cuts to prevent economies from sliding into recession, and the RBI could do worse than follow that lead. GDP forecasts now converge around a figure that is a good two percentage points lower than the high of nine per cent two years ago. That and falling inflation should be the necessary signals for an easier interest rate regime.

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