Appropriate Under The Circumstances

Updated: Oct 30 2002, 05:30am hrs
The Reserve Bank of India (RBI) had got itself in a bind. The April 2002 Policy had an unusual commitment that the Bank Rate could be reduced by up to one half of one percentage point. The market waited with bated breath for the reduction. By the time of the October 2002 policy, the RBIs internal cautionary signals would have pointed to the end of the cycle of interest rate reductions. But given its public posture, the RBI could not but have reduced interest rates.

2. Appropriately, the RBI has reacted in a curmudgeonly fashion and appeased the lower interest rate lobby with a one quarter of one percent reduction in the Bank Rate, the repo rate and the cash reserve ratio (CRR). Given the commitment, the RBI has brilliantly got itself out of a hole.

3. The RBI has, however, got into another hole that there would not be any reductions in interest rates till March 2003. Now, what if the situation warrants an interest rate increase The RBI would be morally bound not to raise interest rates before March 2003. The interest rate reduction cycle has continued longer than desirable, while the start of the upswing of interest rates will be delayed.

4. Market participants need to take heed of the cautionary stance. In particular, security market dealers cannot continue to operate on the assumption that the era of falling yields will continue. Surely, gilt-edged dealers know their vulnerability, if only there is a slight increase in security yields.

5. The small reduction in CRR has been deftly combined with an increase in the minimum level of daily maintenance at 80 per cent. The tighter the daily maintenance requirement, the faster the RBI can move to its cherished long-term goal of a 3 per cent CRR prescription.

Again, if the RBI were not so generous on interest on CRR balances it would be able to bring down the CRR prescription.

6. While the alteration of the normal and backstop facility for export refinance to one half each, as against two-thirds for normal and one-third for backstop, is in the right direction, it unnecessarily prolongs the agony of phasing out sector specific refinance. There is considerable virtue in a rapid phasing out. The export lobby is very powerful and could well claw back its lost privileges.

7. The RBI intends to set up a

working group to look into extending foreign currency derivatives to rupee derivatives. It is merciful that despite pressures the RBI has not as yet agreed to allow short sales in the government securities market. While setting up the working group on rupee derivatives, the RBI should present to each member a copy of Roger Lowensteins book on When Genius Failed - The Rise and Fall of Long-Term Capital Management (2002). Would members of the working group wish to rush in where angels fear to tread