India funds turn to central bank amid cash crunch

The Reserve Bank of India is considering the proposal to let mutual funds deposit some of the short-term bank debt they hold with the central bank in exchange for cash, said four senior executives, who are involved in talks with the central bank and declined to be named.

Central bank repurchase facilities are normally only open to banks and primary dealers. The central bank's spokeswoman said she could not immediately comment.

Mutual funds would normally sell bank debt on the money market to raise cash to meet redemptions, which should have risen in September as customers pulled out money for quarterly tax payments.

But Indian money markets have been hit by the global financial crisis, which has wrecked banks across the United States and Europe and made lenders around the world wary of dealing with each other.

Aditya Agarwal, managing director and head of Indian markets for fund research firm Morningstar, said the proposal was indicative of the redemption pressures on mutual funds, particularly liquid funds, and was a precautionary step to ensure enough liquidity.

"This is not a panicky but a safeguarding measure," he said.

The cost of overnight borrowing on the interbank market jumped to a 19-month high of 23 percent on Friday, more than double the central bank's short-term lending rate of 9 percent.

The central bank has tried to ease the liquidity squeeze and the executives said it would only agree to the mutual funds' request if the money markets failed to thaw.

The central bank lowered the proportion of deposits banks must keep in their vaults by 150 basis points from Saturday, adding 600 billion rupees ($12.4 billion) to the amount of cash available for lending.

The stock market regulator, the Securities and Exchange Board of India, has asked mutual funds to give details of their holdings of certificates of deposits (CDs), short-term debt sold by banks. This data would be used by the Reserve Bank of India to assess the request for access to the repo facility, the executives said.

"That seems to be the final objective in mind," one of them, a chief executive of an Indian mutual fund house, said.

Waning appetite

CD issuance has ballooned this year as banks scrambled to raise funds to feed demand for credit. Mutual funds have bought them, attracted by returns.

Central bank data shows outstanding CDs at the end of August totalled 1.71 trillion rupees, up nearly 40 percent from the start of the year.

But the appetite for CDs is waning and the cost of borrowing for three months by selling certificates of deposit has jumped to as high as 14 percent compared with between 10 and 11 percent a month earlier, two money market dealers said on Saturday.

That spells trouble for mutual funds at a time of rising redemptions. Customers pulled a net 43 billion rupees out of liquid mutual funds in August after investing a net 630 million the previous month, according to the Association of Mutual Funds in India. The association has yet to release figures for September, when withdrawals typically rise due to quarterly tax payments.

Foreign funds are bailing out of the tumbling stock market, driving the rupee to a record low against the dollar. The central bank is buying rupees to support the currency, exacerbating the cash shortage.

The government has also yet to disburse cash for planned spending, something which would normally boost cash supply in the banking system.

To try to thaw out the market and get banks into lending to each other, the central bank injected a record of 920 billion rupees in its repo operation on Friday.

Liquid funds managed 891.2 billion rupees at the end of August and accounted for 16.37 percent of the total industry's holdings, Association of Mutual Funds in India data shows.