Sunday, April 27, 2008

Differential CRR? That's financial racism.

Finance Minister Chidambaram has a pet peeve. When inflation goes up by a few ticks and he turns to RBI governor Y.V.Reddy for advise, the guv is equally clueless. He knows nothing more than to hike CRR by 25 bps.

A hike in CRR by two tranches of 25 bps each from 7.5% to 8.0% was announced recently by the RBI to suck out excess liquidity from the banking system. But is that enough? It is this predictability that erodes the significance of RBI moves on the economy itself. But stock market nevertheless looks to RBI for direction.

This morning I found Ashok Khemka arguing for nuanced CRR Policy. His key points –

a) Why impose a flat CRR of 8% on all banks’ deposits that looks like a virtual tax? It’s only the sinning few that is responsible for incremental foreign exchange that adds to liquidity. Deposits in domestic currency do not damage the economy. So why not switch to differential CRR on selective foreign exchange inflows (NRI deposits, FII / PE / Hedge Fund inflows) only?

b) Sterilization (mop up of foreign currency by RBI from open market) initiatives have become expensive as reflected by the rise in T-bill yields from 7.4-7.6% from 6.6-7% as was earlier. This taxes the entire economy for the sins of a few.

c) Levy the higher CRR in the designated currency itself. This obviates RBI having to go in for forex mop up later to maintain the exchange rates. RBI can also make that currency reserve available to the needy to buy assets abroad and negates any adverse effect from currency mismatches in international trades.

Great points. But I see those recommendations calling for containment of liquidity by slapping penalties. It is not equal to identifying a mature mechanism that uses the liquidity inflows which is the need of the hour. It amounts to saying `No’ and that is the easiest part. I would look for ways to use that liquidity into creating better infrastructure before foreign investors find another profitable destination outside India. Money is fungible and investors don’t waste much time if they feel they are not welcome here.

Differential treatment is bad. It will mean financial racism. Never do that. Get smart and keep giving them those incentives. You can make hay only while the sun shines on you. Now it is sunny days for emerging markets, especially us. Don’t get smug. Go build better roads, dams, bridges, airports whatever. Don’t slam the door shut on investors. Remember what made Dr.Manmohan Singh open up reforms gate in 1991? We were almost broke. Now don’t get to that point again!

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