The RBI sprung a surprise with a cash reserve ratio (CRR) cut of 0.5 per cent, but otherwise desisted from tinkering with other ratios and interest rates. In its monetary policy statement for 1999-2000 yesterday, the RBI followed through with the wish-list of structural reforms that it had unveiled in its credit policy of April last year. The new policy statement has further buttressed the shift in the RBI's central banking orientation from a monetarist to a structuralist one. This shift is warranted given the observed lack of correlation between movements in money supply enabling liquidity adjustments and the movements of real variables.

The economic ills that a monetary and credit policy calibration is designed to address have not changed significantly over the last couple of years. While fears of short-term volatility in the financial markets havereceded, the longer-term recessionary conditions look set to becoming chronic. What has changed, quite dramatically, is the orientation of the entire banking and financial sector to the market. Interest rates, save for savings deposits and time deposits for less than 15 days and for directed loans, had been freed.

The emphasis of the RBI is patently on restructuring the financial markets to reduce the transactions costs, illiquidity and fragmentation of the various markets so that the entire interest rate yield curve moves down and becomes more responsive to RBI monetary policy signals.

The compulsions of the RBI in juggling policy objectives are worth repeating; provision of reasonable liquidity; stable interest rates with policy preference for softening to the extent circumstances permit; active debt-management, orderly development of financial markets; and further steps in financial sector reforms. The problem is that the links between the objectives and policy instruments still remain uncertain.

Thecausal effect of manipulating key interest rates and financial ratios consequently remain unpredictable, diluting the impact of monetary policy. Segmenting the interactions of various segtments of debt, credit and capital markets to enhance the effectiveness of regulatory controls, while simultaneously integrating the operations of financial markets, seems to be the RBI's favoured strategy.

Despite the reforms that have been progressively introduced into the banking sector, there is a lot of pre-liberalisation baggage that it still carries-part of it of its own making, and part due to Government directed lending. Interest rates are already at long-time lows, and yet credit delivery remains to a large extent unaffected. The problem here is the conflicting interest of the banking and the commercial sectors. An unwillingness on the part of banks to extend credit in deference to the increasingly stingent income recognition and asset provisioning standards in the overwhelming cause for the significantly lowerincrease in bank credit advanced to the commercial sector.

But exporters are unhappy about the policy because it didn't give them concessional credit. The RBI, on the other hand, feels that their real cost of credit is much lower. The argument, as usual, cuts both ways. Exporters can always hedge their net foreign currency liabilities (foreign currency export earnings minus foreign currency loans) by selling expected export earnings in the forward market and earn a forward premium of 7 per cent, but they simultaneously have to cover their foreign currency denominated loans. The net result would still be an effective cost of loans far lower than the nominal 10 per cent that exporters are charged on their rupee loans.

Apart from measures to broaden and deepen the money and government debt markets, the RBI obviously intends to target funds flows to market players in a more specific manner than the previous blanket facilitiers for refinance and general liquidity support. One of the comerstones of the RBI'sstrategy for better liquidity management is the asset liability management (ALM) system that has been mandated for banks and is proposed to be extended to financial institutions.

The interim liquidity adjustment facility (ILAE) is designed as a move towards separating the interbank call and notice money markets from the repos and other short-term money markets. The RBI has also announced its intention to eventually cease to function in its role as underwriter to primary government securities and T-bill issues, letting the Primary Dealers handle the government's borrowing programme.

Interst rates have also been further freed, and banks given more leeway to fix their interest rates. One area that the RBI was expected to have moved forward, but did not oblige to any significant extent, was implementing the Khan Committee recommendations for a move towards universal banking by harmonising the operaetions of banks and financial institutions.

The caution is understandable and the reasons were spelt out in thediscussion paper on banks and FIs released by the RBI. Given the gradual evolution of many FIs from their initial brief of financing long-term project needs of Indian corporates to becoming holding companies of widely diversified institutions, their functional overlap with banks is becoming harder to freeze, and hence regulate.

India is well on its way towards international best practices in banking and finance. The RBI had laid out a road-map for progress towards the Basic norms by 2001 for most banking indicators. The monetary and credit policy for 1999-2000, though not changing these ratios as emphatically as in the past couple of policy statements, has moved significantly towards consolidating the tone established in the past year.