RBI panel suggests move towards single policy rate regime

Reactivation of Bank Rate, 150 bps LAF corridor among recommendations.

In a move that will reduce uncertainty in liquidity and short-term interest rates, a Reserve Bank of India committee has suggested a single policy rate regime, on the lines of the US Fed Rate or the Bank Rate of the Bank of England.

The committee on the operating procedure of monetary policy headed by Deepak Mohanty, an executive director of RBI, said in its report the repo rate should be the single policy rate to unambiguously signal the stance of monetary policy to achieve the macroeconomic objectives of growth with price stability.

KEY TIPS

Fix LAF corridor at 150 basis points  Conduct second LAF regularly  Reactivate Bank Rate  Auction surplus cash balances of the government  Include oil bonds in collateral pool for reverse repo Publish government cash balance daily  Raise daily CRR requirement to 80 per cent

“The repo rate will operate within a corridor set by the Bank Rate and the reverse repo rate. As the repo rate changes, the Bank Rate and the reverse repo rate should change automatically,” the report said.

At present, the repo rate acts as the policy rate when liquidity is in deficit mode while reverse repo becomes the operating rate when there liquidity is surplus. The group feels such a scenario is not a convention followed globally and two rates may create confusion among market players regarding the stance of the policy when liquidity alternates between surplus and deficit mode in quick succession.

It was suggested the optimal width of the policy corridor, that is the gap between the Bank Rate and reverse repo rate, should be fixed at 150 basis points and should not be changed in normal circumstances. The panel felt the corridor should be asymmetric with the spread between the policy repo rate and reverse repo rate, twice as much as the spread between the repo rate and the Bank Rate. “With a corridor of 150 basis points, the Bank Rate should be fixed at repo rate plus 50 basis points and the reverse repo rate at repo rate minus 100 basis points,” it said.

The main objective in the determination of the width of the corridor is to stabilise the overnight money market interest rate while facilitating the development of the money market so that the reliance of banks on RBI facilities comes down over time.

The report recommends the modified LAF should operate in deficit liquidity mode and the liquidity level should be contained around (+)/(-) one per cent of net demand and time liabilities (NDTL) of banks for optimal monetary transmission.

The report also urges reactivation of the bank rate, which has been dormant as RBI is using key policy rates to signal the direction of interest rates. The Mohanty panel says the Bank Rate would be the rate at which RBI would provide liquidity under a new collateralised Exceptional Standing Facility (ESF) up to one per cent of NDTL of banks to be carved out of the required statutory liquidity ratio (SLR) portfolio. The collateral pool for reverse repo operation under the LAF may be extended to include oil bonds.

The committee also recommended an increase in the minimum level of the cash reserve ratio requirement by banks from 70 per cent to 80 per cent on a daily basis.

Source: Business Standard