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RBI report recommends single policy rate

RBI report recommends single policy rate
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First Published: Tue, Mar 15 2011. 05 35 PM IST
Updated: Tue, Mar 15 2011. 05 35 PM IST
Mumbai:Reserve Bank of India on Tuesday recommended the use of the repo rate as a single policy rate, in line with global practice, to clearly signal its policy stance.
The report, by the central bank’s working group on operating procedure of monetary policy, also suggested that liquidity should be maintained in a deficit mode for effective policy transmission.
The central bank has sought feedback on the report from banks and market participants by end-March.
“The repo rate should be the single policy rate to unambiguously signal the stance of monetary policy to achieve macroeconomic objectives of growth with price stability,” the Reserve Bank of India (RBI) said in the report.
The repo rate, the rate at which the central bank lends to banks, now stands at 6.50% while the reverse repo rate, at which it borrows from banks, is at 5.50%.
The report recommended reactivating the Bank Rate, also known as the discount rate, which was the refinance rate that existed prior to the current liquidity adjustment facility (LAF), which the central bank uses to manage liquidity. “The single rate thing is a good recommendation as this is a global practice and I also agree with the fact that liquidity should be kept in deficit mode for effective policy transmission as that is also a standard international monetary practice,” said A. Prasanna, economist at ICICI Securities Primary Dealership.
The Bank Rate is recommended as the upper bound of the rate corridor and banks can dip into an additional 1% of their deposits, if they fall short of statutory liquidity ratio (SLR), to borrow from the central bank at this rate, the RBI said.
“The recommendation of maintaining banking system liquidity in “deficit mode” and introduction of a standing facility of 1% of SLR for borrowing funds from the RBI at bank rate, would tend to keep call rates anchored around the repo rate,” said Gaurav Kapur, senior economist, Royal Bank of Scotland.
The LAF came into existence in June 2000, prior to which the RBI used to extend refinance to banks at the Bank Rate.
Last September, the RBI had set up this working group to review the operating procedure with respect to repo, reverse repo auctions, width of the interest rate corridor, and frequency and timing of reverse repo and repo auctions in light of global best practices and domestic experience.
The committee suggested a 150 basis points spread between the Bank Rate and reverse repo rate and said, these two rates will change “automatically” when the repo rate changes.
“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,” the RBI said.
Cash reserve ratio or the proportion of funds that banks must maintain with the RBI as cash currently stands at 6 percent.
Banks are required to report their holdings to the RBI every fortnight. However, on a daily basis too, banks are currently required to meet at least 70% of their CRR needs, which the committee has recommended must be raised to 80 percent.
Inclusion of oil bonds under the list of collateral for reverse repo auction was also recommended.
“If they are allowing non-SLR bonds like oil bonds, then why not fertiliser bonds, other corporate bonds,” said a foreign bank dealer.
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First Published: Tue, Mar 15 2011. 05 35 PM IST
More Topics: Central Bank | RBI | Policy Rates | Bank Rates | SLR |