On 20th of this month the call rates shot up to 70% (even though this was on stray deals). The reason being attributed to this is the liquidity crunch arising out of advance tax outflows. However, I feel that this stray spike in the call rates is no indicator of long term fundamentals on the interest rates. It was just a single day anamoly and should be treated as such. I have time and again reiterated the necessity of a strong banking system for capital account convertibility. However the banking systems’ state on tuesday only shows the immaturity of our banking system. Normally there is a liquidity crunch at the end of every quarter when the corporates pay advance tax. This crunch is even more pronounced during the last instalment to be paid in March. Keeping in mind the kind of bottom line growth the corporates have been posting during the last year, any sane person would have known that tax outflows for the FY 2006-07 would also be very high. Hence some tightening should have been expected and the banks should have prepared themselves beforehand. Moreover remember in my previous blog on CRR I had mentioned that the last tranche of CRR hike would result in some tightness as it would immediately follow the tax outflows. Had the banks carefully planned their cash flow positions they need not have pressed the panic buttons and let the call zoom to such rates.

Foreign banks and the new generation private sector banks, in their drive to maximise profits, are overstretching themselves by lending much in excess of their deposits. The excess lending is financed through short term borrowings (including call).These banks would have no option but to keep borrowing irrespective of the rates to fund their lending. This is what is called as asset liability mismatch. While this mismatch might yield good profits under normal situation, however when there are sudden spikes in the short term rates it could create problems for the banks.

Rupee Dollar Movement
We have been studying this in MAFA. Now you can see this happening in real life. Rupee has appreciated from 44.25 to a $ on 22nd February to 43.45 to a $ yesterday. Clearly this would hit the exporting companies very hard. The dollar proceeds received by such export companies would now realise much less than what it would have realsied on 22nd February. (Except of course for people who had taken forward cover). This appreciation of rupee vis a vis the dollar will straight away knock off a significant portion of the top line as well as bottom lines of such companies. Of course exporters who have planned and seasonal exports wont be hurt much as they would have taken forward covers but for industries which thrive on spot orders (especially commodities) the hit would be higher.

One can see a linkage between the rupee dollar movement and the call money rates. As the call rates shot up treasury managers would have sold dollar and bought rupee resulting in the dollar depreciating vis a vis the rupee.

US Fed keeps interest rate unchanged
The US Fed did not change the interest rate and kept it unchanged at 5.25%. So possibly we can also heave a sigh of relief and hope for some respite from the continuosly increasing interest rates. PM Manmohan singh on Wednesday played down the fears of overheating in the economy, saying rise in inflation rate is a temporary phenomenon as growth impulses in India are very strong.


1 Response to “”

  1. 1 Rohan Samant March 22, 2007 at 11:08 am

    This is the repetition of what happened in December. Due to advance tax payments, liquidity was tight and call went soaring to 15%. RBI pumped in liquidity to stabilize the call rate and then immediately raised CRR.

    This time too RBI has pumped in some 45000 CR Rs into the system. Why should RBI take such an action? when it knows that the spike in call rates is only a short term aberration and call rates would stabilize going forward. Just two weeks back call rate was below 6%.

    One more question Sir – Do you think rupee will depreciate (against the dollar) if the call rate comes down again to 6-7%, considering the fact that Fed may start cutting rates going forward which would be bearish for the dollar?

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