The currency and finance report of the Reserve Bank of India (RBI) made a strong pitch for letting the central bank tweak the policy corridor while leaving the decision to change repo rate through a consultative approach by the six-member monetary policy committee (MPC), in which the governor is the chair and has a casting vote right to arrive at a decision in case of a draw.
The policy corridor is the gap between repo rate, at which the central bank lends to banks, and the reverse repo rate, at which liquidity is drained out. An emergency liquidity borrowing facility is available called marginal standing facility (MSF) through which banks can borrow funds by paying 25 basis points extra above the repo rate.
The currency and finance report, which the central bank claims is not its official view, says the RBI must retain the freedom to tweak the reverse repo and MSF rate for liquidity management purposes. These rates are linked with repo, and by deciding on the repo rate action, the MPC can effectively decide on the course of these rates as well, the report argued.
The report said “decisions involving a change in the reverse repo rate and the MSF rate and announcements thereof may be shifted out of the MPC resolution to the Reserve Bank’s Statement on Developmental and Regulatory Policies.”
Additionally, the RBI should also clarify for the purpose of anchoring expectations that in normal times it will work within symmetrical corridor with the MSF rate and the fixed rate reverse repo rate at prespecified alignment with the policy repo rate and that it “reserves the option of operating with an asymmetric LAF corridor in exceptional times.”
While the MPC must determine the policy repo rate required to achieve the inflation target, the policy rate itself is part of the liquidity adjustment facility corridor.
The operating procedure of monetary policy is guided by the objective of aligning the operating target of monetary policy – the WACR (weighted average call rate) – to the repo rate through active liquidity management, consistent with the stance of monetary policy.
The RBI was criticised when it cut reverse repo in an out of turn decision on April 17. Critics, including former governor Urjit Patel, had said this undermined the MPC.
But the report argues that the day-to-day liquidity management function is “solely in the domain of the Reserve Bank,” the report said.
“During normal times, the reverse repo rate and the MSF rate move in sync with repo rate changes as they are pegged to the repo rate in an equidistant manner under a symmetric corridor. In exceptional times, however, the corridor itself becomes an instrument for managing liquidity conditions. As the marginal standing facility and the fixed rate reverse repo windows are essentially instruments of liquidity management, they are in the remit of the Reserve Bank,” the report said.
The corridor was made asymmetric on March 27 by reducing the reverse repo rate by an additional 15 bps over and above the 75 bps reduction in the repo and the MSF rate. The result is that the WACR became aligned closely with the reverse repo rate.