The government and the Reserve Bank of India have identified dollar shortage as the principle cause for the liquidity crunch which is still there in the financial system. The central bank is expected to take adequate steps to address this issue. Meanwhile, government sources said the market regulator may issue a formal order to FIIs to reverse short-positions created before October 20.

Here is a verbatim transcript of Abhijit Neogy’s comments on CNBC-TV18. Also see the accompanying video.

We have been talking to government sources to essentially try and find out what is the main problem now in the system. Is it rupee liquidity? Is it something that to do with the market? Is it short selling? The issue that we are picking up right now is dollar shortage which is the main problem in the financial system right now. Government sources would have us believe it is essentially because of dollar shortage that is actually feeding into the rupee shortage into the system. Now, how do you deal with this?

There are several options which are available. What the RBI is trying to figure out is which maturity bucket of the dollar are we talking about? Is it the 90-days dollar stream or are we talking about the 180-day dollar stream? They are trying to identify which dollar maturity bucket is actually causing the most shortage in the system and they are trying to attack that. We understand that RBI is in receipt of data which actually says that overseas straight credit in dollar denomination is something that is really clogged at the moment. It is really sort of dry in terms of dollar funds and that has tenure of 15-90-days. We are talking about credit here and I am sure that RBI is going to attack that problem.

One of the options that RBI is discussing right now with the Finance Ministry is whether the dollar-repo window could be sort of opened in-line with what we see in some East Asian economies, so that the rupee liquidity situation is untouched at the same time dollar flow into the system actually goes up. So, that is something that they are trying with. We understand that the Finance Ministry and the RBI has discussed this and they are basically on the same page. We could see some RBI action on that front.

Will there be an order in terms of reversing the FII short positions? What's the timeline for that?

As far as the short selling issue is concerned, we do understand that the Sebi is close to finishing off the examination of FII lending data and the short positions taken by FIIs pre-October 20. It may actually now issue a formal order asking FIIs to reverse those short positions. So, Sebi might now actually issue a formal order asking short positions created by FIIs before October 20 to reverse their positions. That could be out today or possibly before Monday. According to the data that Sebi has right now, they believe that given the current market cap, even at these depressed price levels, the short sales to market cap is still insignificant. They are saying short sales could not have contributed so significant to the depression of prices in the current market. In fact after this current crisis tides over, they are in fact thinking in terms of enhancing the regulatory framework for FII short sales in the economy.