S. Balakrishnan

In a clever move, the Reserve Bank of India has left the reverse repo rate the rate at which banks can place funds with the central bank unchanged while increasing the repo rate the cost of borrowing from its window by 25 basis point. Surplus liquidity will no longer benefit every time there is a rate hike for monetary reasons.

In highly- developed money and financial markets, the central bank steers market rates to its desired repo (or discount) rate through open market operations. Our financial system, though improving rapidly, still lacks the instruments and depth to align central bank and market rates, necessitating a wide corridor between the repo and reverse repo rates. Somehow, the possibility of variable repo rates within a range to take account of the daily changing liquidity situation has not found favour yet. There is no question: In monetary terms, the RBI has tightened more than would have been the case if the reverse repo rate had also been increased.

Inflation continues to be a concern and the RBI states it would consider the job well done if contained to 5-5 per cent. The transparent goal will help in reaching gradual adjustments and the right levels depending on incoming data and (hopefully) reduce volatility in the bond and forex markets.

The Tarapore Committee II on Capital Account Convertibility tactfully ducked a direct answer to the issue of allowing unfettered cross-border financial mobility, while suggesting token increases in outward remittances and offshore investments for resident individuals but across-the-board significant freedom to corporates for overseas acquisitions rightly so as many Indian companies have now come of age and must now be enabled to become multinationals.

The RBI has accepted the spirit and thrust of the recommendations of CAC-II and most of them have found acceptance in specific measures forming part of the policy. Peace from the pressures of those for whom CAC is a `cherished goal' has been bought relatively cheaply.

A surprise is the flexibility given to the Foreign Institutional Investors to rebook forward contracts. One would have thought rollovers to match, more or less, exit of the investment would be the right hedge for them against rupee depreciation. Freedom to cancel and rebook runs the risk of speculative activity (for or against the rupee) at awkward times for the RBI and runs somewhat counter to its reservations on investments through the PN route. In effect, the non-deliverable forward (ndf) dollar-rupee market thus far confined to offshore financial centres now has official sanction. Overall, a balanced approach in line with what one has come to expect from Dr Y.V. Reddy.

(This article was published in the Business Line print edition dated November 1, 2006)
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