Hard to ease liquidity amid high inflation, says Subbarao

The Reserve Bank of India faces a challenge in easing liquidity without signalling that it is loosening its anti-inflationary monetary policy stance, Duvvuri Subbarao, governor of the central bank said today.  Liquidity in India’s financial system has been tight over the last few months, largely due to lower-than-expected government spending, forcing banks to borrow on average a net of around `850 billion ($18.72 billion) a day from the central bank at its repo window from November through January. The figure has in February dropped to around `720 billion on the back of some pickup in the government spending but advance tax outflows in March are expected again to tighten cash conditions.  India is also battling stubbornly high inflation, standing at 8.43 per cent in December, and easy cash conditions could aggravate the inflationary pressures.  “The dilemma is how to manage liquidity, ease liquidity without giving the message, indication, impression that we are loosening our anti-inflationary stance,” Subbarao said.  “We do it either by CRR (cash reserve ratio) or by OMO (open market operation) but the question is if we reduce the CRR or do OMO in a situation, in acontext when we are trying to signal an anti-inflationary stance, the fear is the market gets mixed signals,” he said while speaking in central India.  CRR is the percentage of deposits that banks must set aside with the central bank as cash, and some market participants have been expecting a cut in this ratio to help ease the tight cash.  In a bid to help ease the severe liquidity crunch in the market, the central bank in its December monetary policy statement announced a four stage open market operation programme, offering to buy up to `480 billion from the market. The RBI has said it wants to keep liquidity in the banking system in a range between a `500 billion shortfall and a `500 billion surplus, or more generally a deficit or surplus of 1 per cent of banks’ total deposits.  However, the central bank may have to move cautiously on any liquidity easing measures, as inflationary pressures are expected to persist in the current calendar year.  Inflationary pressures from domestic sources as well as global commodity prices may intensify in some cases, RBI Deputy Governor Subir Gokarn said today, making the RBI’s job of balancing fighting inflation and easing liquidity that much more difficult.