Policy to get attuned globally

Large forex inflows into the Indian financial system is increasingly making the monetary policy more global in outlook.

To be precise, the importance of global interest rate movements is increasingly coming into focus while deciding monetary policy by the central bank given the high intensity of such inflows.

Forex inflows, adding to the large swings in liquidity conditions, are posing problems for the central bank in targeting short-term interest rates.

The call money rate, which the RBI wants to be in a band of 6-7.75 per cent have witnessed huge swings in recent months. The overnight call money rate had swung to a high of 80 per cent last month and was less than 1 per cent today.

Though the Reserve Bank of India (RBI) has progressively de-emphasised the use of reserve requirements as an instrument of monetary policy, it finds it necessary to retain the flexibility of using reserve requirements as and when necessary, given the present state of market development.

The RBI said there was a need to further refine the system of assessing liquidity conditions, which calls for an improved framework of liquidity forecasting. The rapid change in a short span in liquidity conditions has posed a major challenge for targeting short-term interest rates.

The understanding of the fiscal position and the government's cash balances as also the timing and extent of capital inflows assume added significance. In this context, there may be a need to consider the regular release of information on government cash balances held with the RBI.

Progressively, more weightage needs to be given to movements in international interest rates in view of increased capital mobility. Again, destabilising large and sudden capital flows call for more flexible and swift monetary policy responses through small and gradual changes in policy rates, as has been practised in recent years, as large changes can be disruptive.

The apex bank has raised its key signalling (repo and reverse repo) rates nine times since 2004 to curb inflation and also raised cash reserve ratio (CRR-the proportion of deposits banks have to keep with the central bank), thrice by 50 basis points each since December to 6.5 per cent.