The Reserve Bank of India (RBI) today said it needs to fine-tune policy instruments to ensure that overnight call money rates stay between the repo and the reverse repo rates.In its Report on Currency and Finance 2004-05, RBI said the opening up of the economy and management of liquidity due to strong capital flows were posing a challenge in the medium-term."As there is a trade-off between the excessive volatility in financial markets, exchange rates and interest rates, which are likely to result in erosion in the competitiveness of the economy on the one hand and financial cost of sterilisation on the other, the Reserve Bank has to properly balance its sterilisation operations," the report said.The growing remittances from Indians working overseas and pumping of funds in the Indian capital markets by foreign institutional investors led to huge foreign funds being available in the market. This caused overhang of liquidity in the financial market, making RBI to issue securities (bonds) to suck out excess liquidity under the market stabilisation scheme (MSS).Keeping the costs in mind, RBI will have to properly balance its sterlisation operations. This would also call for efforts to keep call money rates within the corridor of the repo and reverse repo rates, the report said. The reverse repo rate, the rate at which RBI sucks out liquidity from the market, is 5.5% and the repo rate, at which the central bank injects liquidity into the banking system, is 6.5%.Reserve Bank absorbs the valuation impact of exchange and interest rate movements in the international market. The sterilised intervention has meant adjustment on the assets side of the RBI balance sheet (substitution of domestic assets by foreign assets). The use of MSS bonds has caused an expansion of the balance sheet. Such expansion of the balance sheet may necessitate corresponding increase in contingency reserves, the report noted.RBI has initiated several measures to ensure revaluation of both domestic and foreign assets on a prudent basis, and also build up adequate cushion in the form of contingency reserves so as to impart policy flexibility in a liberalised environment.Referring to near-term developments, RBI said it would cease to participate in the primary auction of central government bonds from April 1, 2006. It would separate the debt management function from the monetary management operations, and give RBI more control over the composition of its balance-sheet and flexibility in monetary management. It would also call for greater co-ordination between the Reserve Bank and the government for ensuring stability in the financial markets.
