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P. Devarajan

IN a surplus rupee scenario, the Reserve Bank of India would prefer the bank rate/reverse repo (funds given by the central bank against securities), to cap the interest rate corridor. The proportion of entitlement under back stop facility in total refinance has been raised to 67 per cent and the Working Group recommends "that the entire refinance should be made available at the reverse repo rate so that the refinance window operates as a marginal lending facility, and along with the bank rate/reverse repo rate, it would provide the upper bound to the interest rate corridor."

At present, the repo rate provides the lower bound to the interest rate corridor as the eligible cash balances under CRR is remunerated at the bank rate (6 per cent), which is higher than the repo rate. In fact, banks are placing rupee funds in repo and RBI wants to halt the practice with a special deposit facility earning a tad less than the repo rate. The group says: "In this context, it needs to be appreciated that the special deposit facility would be in the nature of an uncollateralised standing facility. However, the apprehension that unlimited amount of funds could be placed with RBI under this facility which might dampen the lending activities of banks would be unfounded provided the call rates are kept around the policy repo rate. In such a scenario, there would be an incentive on the part of market participants to deploy resources first in the market on account of higher return that it would fetch and come to RBI only when they would not be in a position to deploy funds around the targeted rate. In the process, the special deposit facility rate would provide a firm floor to the behaviour of call rates while the repo rate would continue to provide the signalling stance from RBI."

With regard to the spread, the group is in favour of fixing the reverse repo at 150 basis points above the repo rate (funds placed with RBI against Government Securities), with the deposit facility rate set 100 basis points lower than the repo rate. The corridor will have a spread of 250 basis points with the policy repo rate being placed within the corridor.

The group is keen on the overnight interest rates hovering around the repo rate in the corridor. But does it not imply that the repo rate needs to be variable instead of being a fixed affair?

In case the market turns illiquid, the reverse repo rate would become the signalling rate. The special deposit facility (which may not be used at all as there may not be excess funds to park) will bear an interest rate lower than the reverse repo and would form the floor. Anyway, no bank will place funds in this facility during times of monetary tightness.

The group firmly believes that today the repo rate has dislodged the bank rate as an indicative rate. Earlier, repo rate alterations followed shifts in bank rate, but in recent times the trend has been reversed with changes in bank rate following revisions in repo rate. From here it is not unnatural to find the group arguing in favour of repo.

The group, however, felt "that while the bank rate may continue to be linked to certain specific operations of RBI such as CRR/SLR defaults and General Line of Credit to Nabard, its policy signalling effect may decline in the future. The role of the bank rate would thus be a liquidity injection rate from the RBI similar to the reverse repo rate. This will also enforce the upper band of the interest rate corridor and would enhance the effectiveness of interest rate channel of monetary transmission.

The group, therefore, recommends that the RBI may continue to announce the bank rate independently as at present. However, the bank rate should under normal circumstances stay aligned to the reverse repo rate in a liquidity surplus scenario and to the marginal lending (refinancing) rate otherwise.

But what about the linkages with the lending and deposit rates of banks as they do not seem to be following market trends? After all, a depositor can earn only 3.5 per cent on his savings account and not the repo rate of 4.5 per cent prescribed by the RBI. Even the best of experts admit that real interest rates are still on the high side. Leave out a few corporates and most of the borrowers in the economy access bank funds and not the markets.

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