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The Rediff Business Special/Ashish Parthasarthy

Banks may yet be able to operate an MMMF without starting an AMC

The Mid-term Review of the Monetary and Credit Policy has been carried out at a time when the economic and political conditions are much more favourable than they were, in April, when the RBI Governor presented the policy for the first half of 1999-2000.

Consider the following:

• On the political front, there is a stable government in place that is looking to press ahead with the so-called "second generation" reforms.
• Agricultural production for 1999-00 is expected to be slightly higher than the previous year due to another successive year of adequate monsoons.
• There seem to be signs of a recovery on the industrial front with the Index of Industrial Production or IIP showing a growth of 6.2 per cent during the period April-August 1999.
• The RBI expects the gross domestic product or GDP to grow in the range of 6 to 6.5%.
• Inflation currently is at a low, single-digit levels and the RBI expects the annual inflation for 1999-00 to be lower than previous year's figure of 4.8 per cent.
• The RBI has managed to complete around 86 per cent of the central government's gross market borrowings accompanied by a fall in yield on government securities.
• The present level of foreign exchange reserves (US$ 33.07 billion) have shown a year-on-year growth of US$ 3.43 billion during a period of domestic as well as global uncertainties.
• The RBI expects the current account deficit to be below 2 per cent of the GDP for 1999-00.

Now we will take a look at some of the significant aspects of the mid-term review.

Interest rates:

Despite the improved economic and political situation, the RBI has continued to adopt a cautious stance in case of the monetary policy. In its own words, the stance of the monetary policy would continue to be "provision of adequate liquidity, stable interest rates with preference for softening to the extent possible within the existing operational and structural constraints.

While the RBI feels that there is a case for downward movement in the structure of interest rates given a decline in inflation rates and a relatively favourable outlook for the year, it has said the prime lending rates are entirely within the purview of banks and by implication that the ball is in the banks' courts.

However, the reduction of CRR by one per cent, which increases the lendable resources of banks by Rs 70 billion, is unlikely to result in a reduction in bank PLRs. Already some large banks and financial institutions have stated that they are not going to reduce their lending rates.

The CRR cut will only ensure that the short-term interest rates, which had hardened over the last two months, will come down. Medium- and long-term interest rates are likely to remain at current levels.

The CRR cut would definitely help the profitability of banks whose margins were under severe pressure. Interest rates are unlikely to be lowered by banks since they face several constraints, some of which have been mentioned by the RBI as follows:

• Large volume of market borrowings by the government giving an upward bias to the entire interest rate structure.
• Higher level of interest rates on contractual savings like provident funds, national saving certificates.
• Higher level of rates offered by private sector mutual funds. Compared to bank deposits, many of the other savings schemes and mutual funds carry larger tax benefits.
• High level of CRR which raises the average cost of funds for banks.

The RBI has stated that removal of some of the above constraints should be an important policy priority for itself, government and banks.

Year 2000 or Y2K preparations

The RBI has announced a very strong support system for anticipated enhanced liquidity needs during the century date period. All the following measures announced by the RBI would be valid for the period December 1, 1999 to January 31, 2000:

• The RBI has announced a "Special Liquidity Support" measure under which banks will be eligible to avail of liquidity to the extent of their holdings of dated Government of India Securities/Treasury Bills over the SLR required to be maintained. The rate of interest on this facility would be 2.5 per cent over the bank rate. This means that liquidity will be available to the banking system at a cost of 10.50 per cent (present bank rate is 8 per cent). The banking system is estimated to hold securities in excess of the SLR requirements to the extent of around Rs 600 billion. Thus, theoretically, this amount of liquidity will be available to the banking system during this period. The RBI has also asked those who do not hold any significant amount of excess SLR, to get into standby arrangement with banks who hold excess SLR securities.
• During this period, the cash held by banks will be counted towards the maintenance of CRR. Currently, banks' holding of cash in their vaults is reckoned for SLR purposes. It was feared that during this period, banks may have to hold cash in hand much in excess of their normal holdings. This would cause a reduction in the bank's balances in their current accounts with the RBI. The reduced current account balances, which are reckoned towards maintenance of CRR, could have caused an additional demand for liquidity. By equating, for CRR maintenance purposes, the current account balances with the cash in hand, the RBI has not only dealt with this anticipated liquidity problem but ensured an additional liquidity of around Rs 50 billion, which is the current holding of cash with banks.
• The RBI has also allowed overseas banks to freely access liquidity from their respective head offices overseas during this period.

In fine, the contingency plan put in place by the RBI for Y2K liquidity needs is an excellent and well thought-out plan and will be more than adequately serve its purpose.

Money Market Mutual Funds

Finally, the issue of regulation of money market mutual funds or MMMFs seems to have been settled. The RBI has said that henceforth MMMFs will fall under the purview of the SEBI regulations and that it would withdraw its guidelines once SEBI puts a regulatory framework in place. The RBI has further announced that MMMFs will have to be set up as a separate entity in form of a 'trust' and that the Money Market Deposit Account structure will no longer be permitted.

The implications of this measure are as follows:

Presently, MMMFs are subject to a 15-day lock-in period. So we have the absurd situation of an MMMF being less liquid than a bond fund. Since SEBI has no lock-in period for any type of fund, it is expected that the lock-in constraint in case of an MMMF will no longer exist. Banks may yet be able to operate an MMMF without starting an asset management company or AMC, but it will have to be in the form of a "trust" which will be registered with SEBI. Since the MMMF will be registered with SEBI, its income will become exempt from income tax as per the provisions of Section 10 (23 d) of the Income-Tax Act. At present, each MMMF has to seek a special exemption from the Central Board of Direct Taxes.

Other liberalisation/deregulation measures

• Banks have been given freedom to charge interest rates without reference to PLR in case of certain categories of loans and advances.
• Mutual funds have been permitted to undertake forward rate agreements and interest rate swaps for hedging purposes.
• The RBI has granted general permission to Indian companies under the automatic route to receive funds and issue shares to their foreign collaborators without approval of the RBI.

(SLR = statutory liquidity ratio. Banks in India are required to maintain 25 per cent of their demand and time liabilities in government securities and certain approved securites. These are collectively known as SLR securities. The buying and selling of these securities was the seed of the 1992 scam. Back to the analysis.)

The writer is vice-president and head, money markets desk, HDFC Bank, Bombay, India.

ALSO SEE

RBI Governor Bimal Jalan's policy statement

RBI's Credit and Monetary Policy 1999-2000

RBI's Credit and Monetary Policy 1998-1999

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