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The RBI recently released its Report of the Working Group on Operating Procedure of Monetary Policy (WGOPMP) under the chairmanship of Mr Deepak Mohanty. Largely, the recommendations of the Working Group are notable and timely. Implementation of the key recommendations will definitely improve clarity on several issues.
On Bank Rate
The confusion and inconsistencies associated with the existing role of the bank rate were highlighted in a previous column ( Business Line , June 1, 2010). It was underscored that as the bank rate was delinked from various refinances available to banks from the RBI, including the lender of last resort (LOLR) facility, it has lost its practical significance. With the emergence of the repo rate under the liquidity facility (LAF) as the effective refinance rate, putting the bank rate alongside the repo rate, creates confusion.
The bank rate had also become redundant as it remained unchanged for a decade, despite swings in policy stance, during the period.
The Report of WGOPMP is highly commended for not only re-assigning a credible role to the bank rate as a monetary policy instrument, but also removing the confusion regarding its relevance and role vis-à-vis other policy rates.
On a single policy rate
In addition to the above, there was also some confusion on the role of the repo rate vis-à-vis reverse repo rate under the LAF as the RBI policy rate. It was widely interpreted that during the tight mode of monetary policy, repo rate (ceiling of the LAF corridor) becomes the effective policy rate, while during the monetary accommodation phase, the reverse repo rate (floor of the LAF corridor) plays a similar role. Accordingly, it was observed that the interbank ‘call money rate' hovered around the repo rate during tight monetary mode and close to the reverse repo rate during monetary accommodation.
This used to be at variance with cross-country practices, where a single policy rate signifies monetary policy stance. This rate is raised during the tightening mode and reduced during accommodation. The recommendation of the WGOPMP to adopt the repo rate under LAF as the single policy rate is noteworthy; this will enhance clarity in policy signal.
In the face of the surging international capital inflows, the RBI's sterilisation operations employed a mix of MSS, CRR variation and liquidity management under LAF. With a single policy rate, it will be imperative to partially separate monetary policy operations from sterilisation operations. Perhaps, sterilisation will involve exclusive use of MSS and CRR variation in the future.
Moreover, it should be noted that in the existing procedure, the RBI de jure retains the discretion on the actual amount of liquidity to be injected/mopped up under LAF. But, it is believed that in the auction process, discretion is not actually practised.
The entire amounts of bids are generally accepted. Implicitly, the RBI seems to be taking up liquidity management responsibility for respective banks. Exercising de facto discretion on the amount is believed to further streamline the liquidity management, both at the system level and for the individual banks.
On Operating Target
In the existing ‘multiple indicator approach' of the RBI, many believed that ‘reserve money' was the principal operating target and ‘call money rate' played a supplementary role. The Report of the WGOPMP mentioned a distinct role of the latter as the operating target. The move is, perhaps, in the right direction, consistent with what is being practised in many industrial and emerging economies, where there is gradual de-emphasis on monetary aggregates.
While overnight interbank rate is a useful tool for quick assessment of immediate impact of policy shocks, monetary aggregates, nevertheless, contain useful information with a medium-term perspective.
Among others, the Report also recommends greater information dissemination to facilitate better liquidity management on behalf of market players. Overall, the Report, unequivocally, lays out an affirmative roadmap for future monetary policy operations of RBI.
(The author is Reader, Department of Economics, Pondicherry University, Puducherry.)
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