RBI releases Report of the Working Group on Operating Procedure of Monetary Policy

The Reserve Bank of India today placed on its website the Report of the Working Group on Operating Procedure of Monetary Policy (PublicationReportDetails.aspx?UrlPage=&ID=631) (Chairman: Shri Deepak Mohanty). Comments on the Report may please be emailed or forwarded by end-March 2011 to the Adviser-in-Charge, Monetary Policy Department, Reserve Bank of India, Central Office, Mumbai 400 001.

The key recommendations of the Working Group are:

• The liquidity adjustment facility (LAF) with some modifications should be the key element in the operating framework of the Reserve Bank.

• The modified LAF should operate in a deficit liquidity mode and the liquidity level should be contained around (+)/(-) one per cent of net demand and time liabilities (NDTL) of banks for optimal monetary transmission.

• The repo rate should be the single policy rate to unambiguously signal the stance of monetary policy to achieve macroeconomic objectives of growth with price stability. It will operate within a corridor set by the Bank Rate and the reverse repo rate. As the repo rate changes, the Bank Rate and the reverse repo rate should change automatically.

• The Reserve Bank at its discretion could conduct simultaneous auctions for longer period if the liquidity situation so warrants. However, such actions should be at variable prices as they will be purely for liquidity management rather than for signalling the policy rate.

• The Bank Rate should be reactivated as a discount rate as envisaged in the Reserve Bank of India Act, 1934. It will be the rate at which the Reserve Bank will provide liquidity under a new collateralised Exceptional Standing Facility (ESF) up to one per cent of NDTL of banks to be carved out of the required statutory liquidity ratio (SLR) portfolio. The Bank Rate will constitute the upper bound of the corridor.

• The reverse repo rate will have a negative spread on the repo rate and it will be the rate at which the Reserve Bank will absorb liquidity under the LAF. The reverse repo rate will constitute the lower bound of the corridor.

• The optimal width of the policy corridor should be fixed at 150 basis points and should not be changed in the normal circumstance. The corridor should be asymmetric with the spread between the policy repo rate and reverse repo rate be twice as much as the spread between the repo rate and the Bank Rate. With a corridor of 150 basis points, the Bank Rate should be fixed at repo rate plus 50 basis points and the reverse repo rate at repo rate minus 100 basis points.

• The weighted average overnight call money rate should be the operating target of the Reserve Bank. The operating objective should be to contain this rate around the repo rate within the corridor.

• The Reserve Bank should conduct second LAF (SLAF) on a regular basis.

• Persistent liquidity in excess of (+) / (-) one per cent of the NDTL should be managed through other instruments.

• Banks should be incentivised to progressively mark-to-market their SLR portfolio to improve the effectiveness of open market operations (OMO) as an instrument of liquidity management. The Working Group recognises that in due course, the accounting standard would get aligned with the international financial reporting standards (IFRS).

• To improve liquidity management, a scheme of auctioning of government surplus cash balance at the discretion of the Reserve Bank be put in place in consultation with the Government.

• Collateral pool for reverse repo operation under the LAF could be extended to include oil bonds.

• The methodology for the Reserve Bank’s internal liquidity forecast should be strengthened. Information on government cash balances should be put in public domain with minimum time lag for better liquidity assessment by market participants.

• The minimum level of reserves to be maintained on any day by banks with the Reserve Bank during a fortnight should be raised from the present level of 70 per cent to 80 per cent of the required cash reserve ratio (CRR).

• The T+0 transactions for short-term money market segments (collateralised borrowing and lending obligations (CBLO) and market repo) should be extended up to the cut-off timing (i.e., 4.30 PM) for customers in real time gross settlement (RTGS) so that the banking system could square off their CRR position efficiently.

Background

The Working Group on Operating Procedure of Monetary Policy was constituted on October 1, 2010 in pursuance of the First Quarter Review of Monetary Policy for 2010-11 announced on July 27, 2010. Members of the Working Group were drawn from financial markets, academia and the Reserve Bank. The Working Group was assigned the following terms of reference:

1. to survey the operating procedures of major central banks;
2. to review the current operating procedure of monetary policy in India, in particular, the Liquidity Adjustment Facility (LAF);
3. to examine the operation of the LAF with regard to:
1. the width of the corridor
2. the frequency and timing of auctions
3. the maturity period of repo and reverse repo operations;
4. to assess the role of the Bank Rate;
5. to examine the role of standing facilities such as the export credit refinance; and
6. to suggest changes to the current operating procedure of monetary policy in India in the light of international practices and domestic experience, with particular reference to:
1. whether there should be a corridor at all
2. if so, whether its width should be fixed or variable under specified conditions
3. if so, what instruments/mechanisms may be necessary to enable the corridor to function efficiently.

Alpana Killawala
Chief General Manager

Press Release : 2010-2011/1317