In its mid-quarter monetary policy review on December 16, the Reserve Bank of India did not change the policy interest rates, the repo and the reverse repo rates. They remain unchanged at 8.5 per cent and 7.5 per cent, respectively. Nor did it tinker with the Cash Reserve Ratio, which stays at 6 per cent.
The repo rate is the rate at which the RBI lends to banks while the reverse repo is the rate at which it takes money from banks, both against securities.
The repo rate has emerged as the key reference rate. The reverse repo is pegged at one percentage point below it. Those significant changes were introduced in the annual policy statement of May 3, which also saw the introduction of the marginal standing facility whose rate is fixed at one percentage point above the repo rate.
Understanding the intricacies
The absence of changes in the interest rates does not make the policy announcement a non-event. One tends to assume that headline making interest rate moves are the whole of monetary policy. Everything else does not seem to matter.
It ought to be mentioned here that a monetary policy announcement does not cause the same level of excitement, which, say, a budget announcement does. Until recently, monetary policy issues were presumed to interest bankers (to whom it is generally communicated in the first instance) rather than the common man.
To a large extent that was true: for the man on the street there was little to relate to interest rate or exchange rate policies. But the paradigm is surely but steadily changing. Ordinary citizens develop a vested interest — they may own a house bought with a bank loan or financed their children's education through an educational loan. Many, of course, travel abroad making them aware of the intricacies of foreign exchange transactions.
For them and many others, there is a growing need to understand the intricacies of official policies. The list can go on and on but suffice it to say that to the extent official policies are made more accessible, it is in everyone's interest.
Making official policies accessible
The latest mid-quarter review is one of the eight policy statements by the RBI in a year. The increased frequency — one every 45 days — helps the central bank keep in constant contact with the financial markets. It is also part of a process of demystifying official policies.
However, one outcome flowing from the frequent announcements is that the monetary policy statements have become predictable. There are pros and cons in such an approach. On the plus side, there is greater transparency as well as continuity in policy. Important issues discussed just 45 days ago will not be forgotten. For instance, in the quarterly review (October 26), the RBI more than hinted of a soft monetary policy ahead when it said that that the possibility of a rate review in the December statement was ‘relatively low' and that henceforth the monetary policy will have more room for addressing short-term concerns.
The flip side, of course, is that the central bank probably loses its surprise element when it wants to take the market participants by surprise. However, on December 15, the RBI sought to impose curbs on speculation in foreign exchange forward contracts as part of its gambit to stem the rupee's slide against the dollar. The rupee rebounded sharply on the next day. All these show that there is still room for surprise announcements in between policy dates.
Effectively, the RBI had announced a change in its stance in the last policy announcement itself. On the eve of the latest statement, the consensus among money managers and others was that the RBI will maintain the status quo neither reduce the interest rates nor hike them. However, in the days prior to the policy announcement, there were strong arguments for and against a rate hike. Inflation continues to be a main worry, although the RBI is hopeful of containing it within its projected target of 7 per cent by March, 2012. On the other side, growth concerns have begun to occupy the centre stage. “While inflation remains on its projected trajectory, downside risks to growth have clearly increased,'' the RBI said.
“From this point on, monetary policy actions are likely to reverse the cycle, responding to the risks to growth,'' it said.