RBI wants call to stay within repo, reverse repo rate ambit

The Reserve Bank of India (RBI) on Saturday said it needs to streamline policy instruments to ensure that overnight call money rates stay between the repo and reverse repo rates.

In its Report on Currency and Finance 2004-05, the RBI stated that opening up of the economy and management of liquidity owing to strong capital flows were posing a challenge in the medium term.

"As there is a trade-off between 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 RBI has to properly balance its sterilisation operations," the report stated.

Growing remittances from Indians working overseas and pumping of funds into the capital markets by foreign institutional investors have led to huge foreign inflows in the market.

This has caused overhang of liquidity in the financial market, forcing the 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 sterilisation operations. This would also call for efforts to keep call money rates within the corridor of repo and reverse repo rates, the report added.

The reverse repo rate, the rate at which RBI sucks out liquidity from the market, is 5.5 per cent and the repo rate, at which the central bank injects liquidity into the banking system, is 6.5 per cent.

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 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 may necessitate corresponding increase in contingency reserves, the report noted.

RBI has initiated several measures to ensure revaluation of 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.