Reserve Bank Of India (RBI) announced several measures day before yesterday late evening to tighten liquidity in the system and arrest depreciation of rupee. Why RBI wants to tighten liquidity and why the urgency.
RBI had tightened liquidity to support rupee during Asian crisis:
Historically, During the Asian crises of 1997-98, the RBI raised its benchmark interest rate by three percentage points in one go to 8%, in order to attract capital from foreign investors. The RBI had raised the bank rate and cash reserve ratio of banks too. This had sucked out liquidity, and interest rates had skyrocketed. This checked the run on the rupee.
The reason for this move and its impact:
Liquidity had eased considerably in June and that had brought the overnight rates (also CP, CD) rates below the Repo rate. With these measures, RBI will be able to raise the effective short term interest rate considerably without hiking the policy rate. (more…)