Reserve Bank of India Sets Up Group to Review Policy Procedure, Bank Rate

India’s central bank may overhaul its decade-old monetary policy to make local credit markets more responsive to changes in benchmark interest rates, as Governor Duvvuri Subbarao seeks to damp Asia’s second-fastest inflation.

A panel headed by Executive Director Deepak Mohanty will review the difference between the repurchase and reverse- repurchase rates and the frequency and timing of auctions, and assess the role of the bank rate, which has remained unchanged at 6 percent since 2003, the Reserve Bank of India said in a statement on its website.

“The RBI may be doing a reality check on the effectiveness of policy as India’s markets and economy have undergone a lot of change in the past decade,” said Bekxy Kuriakose, who manages the equivalent of $440 million in Indian debt at L&T Investment Management Ltd. in Mumbai. “Certain policy instruments may have lost their relevance while some others probably aren’t used often enough.”

Subbarao, 61, has vowed to cool inflation to 6 percent by the end of March from an average 10.5 percent in the first seven months of this year. He raised both key signaling rates four times since March, while the median forecast of eight economists surveyed by Bloomberg shows he will increase rates by a further half-percentage point by Dec. 31. The central bank’s next decision is due on Sept. 16.

Money Markets

Fluctuations in liquidity, a measure of surplus funds in the banking system, have prompted the Reserve Bank to use two signaling rates to influence money markets. The overnight money- market rate rose to an average 5.23 percent since June 1, from 3.9 percent in May, after companies paid license fees for the third-generation airwaves they won in an auction, which drained funds from the banking system.

India’s increasing integration with the global economy, large volatility in capital flows and sharp fluctuations in government cash balances have posed several challenges to liquidity management, the central bank said in its statement.

“The objective is to make the monetary policy transmission more effective and arm itself to deal with the volatile market conditions more efficiently,” said Shubhada Rao, chief economist at Yes Bank Ltd. in Mumbai. The huge gap between the two operative rates can sometimes hinder the central bank’s broader objective of controlling inflation, she said.

The difference between the repurchase rate, at which the central bank injects funds, and the reverse-repurchase rate, at which it mops up surplus, narrowed to 1.25 percentage point on July 27 as Subbarao increased the latter by 50 basis points to 4.5 percent.

The RBI panel will also have representation from bond traders and bankers, the central bank said.

“We’re unlikely to see any immediate change as the RBI group may take time to complete its study,” L&T Investment’s Kuriakose said.