Wednesday, March 07, 2007

Monetary policy at a crossroads

My column in Business Standard today is titled Monetary policy at a crossroads. It describes nine maladies afflicting monetary policy today, and argues that the problem won't be solved by incremental intensification of the familiar `operating manual' that has been in use at RBI for many decades. One of the maladies concerns the fluctuations of the call money rate away from the corridor - here's the data and a picture. Update (17/3): Suman Bery wrote in BS on the same subject on the 14th.

3 comments:

  1. While agreeing with almost all your contentions, I would still like to qualify and add some perspective to your statements.

    1) Since RBI's repo and reverse repo rates are collateralised rates, it would probably be better to look at CCIL's CBLO rates (for the comparison with the corridor) rather than the call money rates which are rates for clean lending / borrowing. Just to compare apples with apples and oranges with oranges. Your contention that these rates should remain in the corridor is obviously valid.

    2) RBI acting as lender of first resort is true in a limited sense - since borrowing from RBI requires delivery of eligible securities - the supply of which on bank's books seems to have become scarcer over the last two years. Raising deposits require no security on the other hand.

    3)What I have never understood however is Why don't banks fund themselves through the swaps market. Three month interest rate swaps currently rule at 7.75% - meaning three month money can be had at 7.75% through this route. Being a fund manager, I can tell you three month rates for bulk deposits are currently close to 11%, a conundrum I have never been able to understand. Of course, I must be missing something since it the treasury function in banks is staffed by clever individuals who are unlikely to not notice this.

    4) Call money rates falling sharply during the last couple of days - entirely attributable to RBI's move to limit liquidity absorption to INR 30 bn a day - a move that is inexplicable, but probably directed towards weaning away banks from using the daily window to manage SLR requirements. The consequent fall in overnight rates is probably an unintended consequence. I had blogged about it on Friday, immediately after the announcement. Further, what is unclear however, is whether the limits will also apply to liquidity injection. If it doesn't (as it seems so now) - it will clearly go against the stated intent of monetary policy.

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  2. In the previous three posts, one thing is common- the policy making in India is not upto the standards. The policies look more like one step forward and couple of steps backwards.

    One of the solutions is to get more of talent in policy making areas or atleast make it a wanted career option. How many graduates want to get into policy making? And those who even want to, the process is pretty cumbersome one. Most people drop an year or two to prepare for the exams. Why would someone spend so much time if there are other career possibilities which are even more lucrative than polcy making.

    As the article by Mukul Asher rightly mentions, we need reforms in public policy education. It is hightime something is done about it.

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  3. Dheeraj, you say "Since RBI's repo and reverse repo rates are collateralised rates, it would probably be better to look at CCIL's CBLO rates (for the comparison with the corridor) rather than the call money rates which are rates for clean lending / borrowing. Just to compare apples with apples and oranges with oranges. Your contention that these rates should remain in the corridor is obviously valid."

    I think you are applying trading reasoning and not monetary policy reasoning. Your point applies if you are doing arbitrage, but not if you are running monetary policy. The reason why one focuses on whether the call rate is in the corridor is that the entire purpose of the corridor is to control the call rate, which is the rate at which banks trade amongst themselves. By contrast, the CBLO market was established precisely for those institutions (like asset funds) that are not allowed to participate in the call money market, and not allowed to transact with the central bank.

    In brief, monetary policy targets the call rate; the CBLO rate -- like so many other rates -- follows, based on arbitrage and expectations of future rate moves by the central bank.

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