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Liquidity squeezing: has RBI gone overboard?
TRADEINDIA, | 28/09/2016

Last week, the Reserve Bank of India took more steps to squeeze liquidity in the banking system, and the monetary action, which is perhaps the sharpest taken by the central bank in last 17 years, has created a real hue and cry, inviting criticism from many quarters, including economic pundits, bankers, and industry leaders. As per the new guidelines, fresh restrictions are placed on commercial banks\\\' access to daily borrowing under the liquidity adjustment facility (LAF), and minimum CRR balance was increased to 99% as against 70% earlier. I think this new round of tightening measures has enough potential to hurt the economy in several ways.

Of course, the RBI has its own side of the story to tell, but as regards the effect on the Indian industry — particularly the small and medium enterprises — I think the move will have a cascading effect on interest rates. Costs of funds of the commercial banks, particularly that of the small banks that usually use LAF window more frequently will be impacted by the new guidelines, and this will lead to higher interest rates, which in turn will have direct impact on the SME sector, which has long been shouldering the burden of high borrowing costs due to the RBI\\\'s past inflation-fighting measures.

In the bond and stock markets, the negative effects are already evident. After the RBI announcement, the Bombay Stock Exchange benchmark index Sensex lost 211.45 points on Wednesday, 285.92 points on Thursday, 56.57 points on Friday, and 154.91 points on Monday. Midcaps and Smallcaps were also hammered, and the National Stock Exchange benchmark Nifty suffered the brunt as well. Similarly, in the bond market yields on government bonds jumped nearly 0.7 percentage point over two days through Wednesday. These immediate after-effects — although the Rupee has been propped up — raise question in the minds of many about the wisdom behind the RBI decision.

The central bank\\\'s decision could also put our growth forecast at risk. Since RBI started its currency saving measures over the last two months, several global rating agencies have lowered India\\\'s GDP growth forecast for the current fiscal — on July 16, Bank of America Merrill Lynch trimmed it to 5.5% from 5.8% earlier, and the move was followed by three other rating agencies — global financial services firm Macquarie cut the growth forecast from 6.2% to 5.3%, Deutsche Bank from 6% to 5%, and more recently on Thursday Crisil cut it from 6% to 5.5%. Such developments are, of course, not welcome.

And it\\\'s not only about rating — growth can really be hampered due to the RBI move. No doubt the rupee down-slide needs to be arrested, but at this juncture where we stand today it is equally important to push growth and investment. For a long time our industry has been exhibiting a disappointing performance mainly driven by slack in manufacturing the biggest impediment to which is sharp rise in input costs, including high borrowing costs. So maintaining the right balance is very important, and it\\\'s really a great relief — although not enough to make up for the last week\\\'s tightening move — that the central bank, in its policy review today, left the key rates unchanged
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