Of late, Reserve Bank of India
(RBI) executives have been reinterpreting various constituents of monetary policy virtually without any public debate. Worse, their analytical underpinnings are conveyed to the public often through signed articles in RBI
publications. This peculiar situation has arisen because public speeches on monetary policy from RBI
executives have become sparse from January 2013 onwards.
Let us come to the specifics. The Report on Currency and Finance with the theme “Reviewing the Monetary Policy Framework” was published on February 26, 2021. Each chapter with erudition was written by authors to whom the views would be attributed. For our purpose, we will delve into “Operating Procedure of Monetary Policy”. There are at least three areas where authors’ stand warrant serious public debate. The fourth one relates to the views expressed in the Monthly Bulletin in August 2021.
First, the authors claimed that “The WACR (weighted average call rate) should continue as the operating target of monetary policy” (Para IV.40, Page 140). Incidentally, I had argued for substituting the WACR with the tri-party repo rate as the operating target in an article in Moneycontrol on June 11, 2020, because the share of call money market in aggregate overnight money market dwindled from 31 per cent in 2006-07 to a minuscule 2 per cent in March 2021 — a fact acknowledged by the authors. Further, since the share of deals conducted outside the Negotiated Dealing System -Call platform is almost equal to those of the traded deals, price discovery is quite inefficient compared to that in collateralised markets. It is also not deep enough as non-bank participants are ineligible to participate in it. Authors also noted that “the reduced turnover is highly concentrated in the opening and the closing hours of trading, which … accentuate volatility in the WACR”. Yet they argued that “this has not been deemed inimical to the integrity of the call money rate as an operating target by the majority of central banks”.
The authors denounced the collateralised repo markets (tri-party repo constituted 72 per cent of overnight transactions in March 2021) because these “are also populated by non-bank and unregulated participants whose actions may not be consistent with the monetary policy stance or amenable to the central bank’s regulatory control”. This stance is ridiculous because how could non-banks as lenders pose risk to the collateralised segment? Also, with the Clearing Corporation of India as a central counterparty, risk is minimised without distinguishing between a bank and a non-bank. Further, with activity-based regulations in place, non-banks in the money market are bound by directions from the RBI.
Therefore, non-bank entities cannot be characterised as “unregulated participants” who could impede RBI’s actions. Hence, it is difficult to justify why WACR should continue as the operating target of monetary policy.
Second, the authors underscored that “as the marginal standing facility and the fixed rate reverse repo windows are essentially instruments of liquidity management, they are in the remit of the Reserve Bank”. Hence, only the repo rate as the policy rate should be the concern of the monetary policy committee (MPC). This debate owes its genesis to Urjit Patel, former governor, who in the Indian Express on April 28, 2020, delved on how monetary measures changes in reverse repo rate and the spread) were being taken by the RBI without any reference to the MPC.
Now the issue is whether the repo rate in isolation is adequate in the absence of the corridor. The crux is that the entire liquidity management by the RBI is guided by, inter alia, the volatility as well as the spread of WACR around the repo rate. However, these two variables alone may not have much information content without the corridor, e.g., a 20 basis points (bps) spread each in a corridor of 50 bps and 100 bps do have very different connotations. Also without the shock-absorber attribute of the marginal standing facility (MSF) rate and the reverse repo (RR) rate, the repo rate may not have any standing. Hence, the repo rate and the corridor cannot be divorced. Therefore, announcements of changes in MSF rate, RR rate, repo rate and their spread should remain in the exclusive domain of the MPC. Hence, the suggestion that “in its endeavour to achieve the policy rate voted upon by the MPC, decisions involving a change in the RR and the MSF rate and announcements thereof may be shifted out of the MPC resolution to the Reserve Bank’s Statement on Developmental and Regulatory Policies” (Para IV.42, Page 141) needs wider debate.
Third, for sterilisation, the authors proposed: “With the MSF acting as a safety valve on the injection side, it is necessary to impart symmetry to the LAF by providing for a special (deposit) facility (SDF) on the absorption side” (Para IV.46, Page 143).
It is envisioned that while the RR window would continue to absorb temporary surplus liquidity, SDF like MSS could drain out durable liquidity. However, three issues need clarifications.
The authors proposed that “if the reverse repo facility has to be kept active ..., the interest rate on SDF must be lower than the reverse repo (fixed) rate”. Since the maturity period of liquidity absorption under SDF could be much longer than the overnight maturity under RR window, it is unclear how interest rate of longer duration could be lower than that of overnight duration. Further, with no auctions as under MSS, there would be no price discovery process under SDF and the yield curve could get distorted.
Since deposits under SDF would not involve any corresponding transfer of securities from the RBI to market participants, its acceptance could be poor, which could jeopardise the sterilisation process.
3. Corridor systems are characterised by only two standing facilities. Adding SDF on top of the RR facility is, therefore, inconsistent by construction.
Hence, the relationship between SDF and fixed rate RR facility needs to be more prudently fleshed out.
Finally, RBI’s internal dissension has spilled over in the public domain as manifested on pages 59-60 in the article “State of the Economy” in the August Bulletin. What is more shocking is the language used by the authors: “But what if the MPC doggedly attacks the supply shock induced price pressures …”.
Since it has been published in an RBI document, despite the usual disclaimer, can the RBI completely absolve itself of the imprudence? All these unprecedented developments could be obviated if RBI publications are sanitised and public speeches by top executives are encouraged to facilitate more room for debate.
The writer is former adviser to the RBI
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