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Monetary Policy: Highlights of mid-term policy - Views on News from Equitymaster
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  • Oct 29, 2002

    Monetary Policy: Highlights of mid-term policy

    The Reserve bank of India announced the mid-term -- busy season -- monetary policy today. Over the past two years, the Central Bank has systematically moved towards reducing market interest rates, ensuring adequate liquidity in the system and strengthening the banking sector. At the same time, accomplishing the primary objective of maintaining benign inflation rate.

    The mid-term statement, in line with the full year policy, continues to maintain focus towards:

    • Softer interest rate regime
    • Ensuring adequate liquidity for meeting credit growth and investment led demand.
    • Create flexibility in the interest rate structure over the medium term

    In the April '02 policy, the Central bank reduced cash reserves ratio (CRR) by 50 basis points to 5% while maintaining bank rate at 6.5%. This time around, in keeping with the key objectives, CRR and bank rate have been reduced by 25 basis points. The rate cut has surpassed market expectations, which were anticipating no change in monetary policy instruments. Consequently, an immediate reaction could have been strengthening of debt securities across the board. That said, direction provided on interest rates may not necessarily reflect on banking sector lending rates. The Central Bank is addressing the issue by attempting to enhance flexibility in market interest rate structure. Among the initiatives, the RBI has expressed desire that banks and financial institutions move towards a variable interest rate mechanism for deposits. Further, it seems, the RBI is contemplating on liberalizing interest rates on savings account.

    As a measure to further strengthen capital markets, RBI has proposed:

    • Floating rate for Certificate of Deposits issued by banks and financial institutions.
    • Establishing a working group to determine ways for better management of interest and foreign exchange risk by use of derivatives.
    • Introduction of STRIPS (separate trading of registered interest and principal of security) in Government Securities to provide greater flexibility to investors.

    To ensure a growing foreign exchange reserve, the RBI continues to accord priority to the export sector. After reducing the ceiling on foreign exchange loans for exporters to 75 basis points above LIBOR (London Inter-bank Offer Rate), the Central bank has announced a two-phase plan for deregulation of interest rates on pre and post shipment credit. The objective is keeping in line with ensuring flexibility in interest rates by removing structural bottlenecks and introducing a competitive environment.

    The RBI has once again mooted the importance of a single regulator for co-operative banks. Consequently, the RBI proposed the setting up of a separate regulatory authority but a Government committee has not accepted the same. The committee has recommended that RBI be vested with regulatory & supervisory powers for the co-operative banking sector. RBI has requested that the Government adopt urgency in removing duality in controls.

    Having said that, with poor performance of the agricultural sector and modest growth in the industrial sector, the Central Bank has revised economic growth -- GDP growth -- downwards. RBI estimates GDP growth at 5-5.5% for the full year, as compared to 6-6.5% at start of FY03. In this light, the unexpected rate cut could be to boost broad market sentiment.



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