By keeping the Reserve Bank of India’s (RBI) policy rates unchanged, Governor Raghuram Rajan has, on the face of it, acted according to market expectations. The RBI has, indeed, retained the ‘repo’ or its overnight lending rate to banks at 8 per cent. But Rajan’s first monetary policy statement for the new fiscal is not without his trademark surprise element. And that has to do with allowing banks to borrow up to 0.75 per cent of their deposits/liabilities from the RBI’s 7- and 14-day ‘term repo’ window (against 0.5 per cent now), while halving access to the more familiar overnight repo facility to 0.25 per cent. Banks are currently borrowing roughly ₹30,000 crore daily from the latter window at the RBI’s fixed repo rate of 8 per cent. By curtailing this to ₹15,000 crore, banks will have to henceforth borrow more through the RBI’s term repo auctions at floating interest rates. Given that these have been averaging 8.7-8.8 per cent in recent auctions, the RBI has effectively increased interest rates without saying so.
But the relevance of the RBI’s move isn’t confined simply to the impact on interest rates. Since term repo rates could fall once the liquidity tightness often seen during the financial year-end eases, interest rates may not rise that much. The more important implication is for the fixed repo rate as a monetary policy tool. In the past, it was considered apt to tether the Central bank’s policy to a single, fixed, short-term benchmark lending rate that could be raised or lowered depending on the prevailing inflation-growth dynamics. But now, the RBI has apparently chosen to ‘de-emphasise’ the role of the overnight repo rate, at least as a liquidity management instrument. The demand for liquidity by banks will be met increasingly through variable-rate auctioned term repos. The effectiveness of this move — in line with the Urjit Patel Committee’s recommendation — needs to be seen, especially so when the fixed repo rate is something easily communicated and understood. The markets today clearly know the RBI’s intentions when it hikes or reduces the repo rate.
The other key takeaway from the policy statement is the RBI’s firm focus on sticking to a CPI inflation target of 8 per cent by January 2015 — again an endorsement of the Patel panel report. Significantly, it has indicated that any move on interest rates would be dictated by the next government’s stance with regard to minimum support prices for crops, fuel and fertiliser subsidies, and overall fiscal policy stance. A clear political commitment to fiscal consolidation from the next government is certainly in the economy’s interest. Interest rates need to come down, which can happen only with fiscal and monetary policy being in sync.