All eyes are on the Reserve Bank of India (RBI). The market is divided on the size of the expected policy rate hike on Tuesday.
The choice is between a 25 basis points and 50 basis points increase in policy rates. The recent 9 per cent WPI inflation for March has shifted market expectations towards the latter.
The RBI policy meet will be important for other reasons too. It is expected to provide forecast on GDP growth, inflation for 2011-12. A focal point will be the expected implementation of the recommendations of the Working Group to evaluate monetary policy operating procedures.
The RBI had constituted this working group in 2010 under the chairmanship of Mr Deepak Mohanty, an Executive Director at the central bank.
Single operative rate
This Working Group recommended using a single operative rate (repo rate) to signal RBI's monetary policy stance. Currently, both the repo and reverse repo rates are used to signal monetary policy stance.
“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. It will operate in 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 Working Group recommended.
Policy corridor
The Working Group had also suggested that the optimal width of the policy corridor be fixed at 150 basis points and should not be changed in the normal circumstances. It recommended adopting a newly defined bank rate fixed at 50 basis points above the repo rate and fixing the reverse repo rate at 100 basis points below the repo rate.
The RBI should endeavour to keep liquidity in deficit mode to improve monetary policy transmission, it has been suggested. To improve liquidity management, government surplus cash balances held with the RBI should be auctioned. Also, banks should be incentivised to progressively mark-to-market their held-to-maturity portfolio to improve participation in the central bank's open market operations, according to the Working Group.
Meanwhile, ahead of the policy announcement on Tuesday, the rate sensitives such as banking and auto stocks got battered at the stock exchanges on Monday.