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The changing face of Monetary Policy

BS Banking Bureau

The twin objectives of the Monetary & Credit Policy continues to be maintaining price stability and ensuring availability of adequate credit to the corporate sector.

However, the traditional emphasis on the use of broad money as an intermediate target has been de-emphasised although the growth in broad money (M3) continues to be used as an important indicator.

The composition of reserve money too has changed with net foreign exchange assets currently accounting for nearly one-half of reserve money.

Since 1998-99, the Reserve Bank of India has been adopting a multiple indicator approach in its monetary policy.

In this approach, interest rates or rates of return in different markets like money, capital and government securities markets are juxtaposed with data on currency, credit extended by banks and financial institutions, fiscal position, trade, capital flows, inflation rate, exchange rate, refinancing and transactions in foreign exchange, etc. to draw policy perspectives.

The thrust of the policy in recent years seems to be to develop an array of instruments to transmit liquidity and interest rate signals in the short-term.

The RBI introduced a liquidity adjustment facility in June 2000 to modulate short-term liquidity and signal short-term interest rates. The LAF operates through repo and reverse repo auctions and sets a corridor for the short-term interest rates.

The medium-term objective of the policy is to make the call and term money market purely a market for banks, while non-bank participants - who are not subject to reserve requirements - can have free access to other money market instruments and operate through repos in a variety of instruments.

Eventually, the overnight market will be an inter-bank market while non-banking participants will rely on repo market.

The Clearing Corporation of India Ltd, managed by the State Bank of India, is expected to facilitate the development of a repo market.

A phased programme for pushing the non-banks out of the call money market has already been announced and the final phase-out will coincide with the implementation of the real time gross settlement system.

The next phase of reforms will see phased reduction of cash reserve ratio to the statutory minimum of 3 per cent, removal of all refinance facilities, capping the call money lending and borrowing by banks and primary dealers and making the LAF a full-fledged system.

The policy is also moving towards reducing subsidies although directed lendings to agriculture, small-scale industry and export sectors are continuing. The ambit of priority sector has been widened to include additional business segments and help banks lend on commercially viable terms.

Another significant development is repositioning of bank rate as the main signalling device. While the repo rate directs the movement of short-term interest rates, the bank rate is perceived to be the signalling device for the medium and long term rates.

However, the bank rate seems to have lost its effectiveness and banks have stopped responding to rate cuts.

The credit pick up has generally been less than projected by the RBI in its monetary policies for quite a few years now. The rates have come down only for a handful of top rated corporates and the flow of resources is also not adequate to certain segments like agriculture and SSIs.

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