RBI Mulls New Money Tools as Inflows Surge

Dec. 3, 2003
By Anirban Nag

BOMBAY (Reuters) - The Reserve Bank of India proposed on Tuesday to introduce new tools in its struggle to manage excess cash with banks in the face of surging flows of foreign money into the economy.

Under the proposals, overnight IOUs that the Reserve Bank of India buys from banks or issues to them -- repos and reverse repos -- would be extended to a one-week maturity, giving them a stronger effect on the money market.

A committee of central bankers also suggested that a new Market Stabilisation Fund would issue debt to complement the government bonds that the Reserve Bank is running out of as it tries to soak up cash from the country's banking system.

Foreigners have been pouring money into India, attracted by its booming stockmarkets and powerful economic growth.

Exchanged into rupees, their investments would leave Indian banks awash with extra cash, pushing interest rates down and inflation up, unless the central bank soaked up that excess money by selling government bonds that it holds.

The deluge of foreign investment has challenged the Reserve Bank's ability to do that; it now has few government bonds left to sell.

"Since the early 1990s, the conduct of monetary policy came under stress with increasing interplay of market forces in the determination of interest rates and exchange rate as a consequence of deregulation," the central bank said in a release.

"In addition, the excess liquidity engendered by capital flows imparted an upward pressure on money supply."

The working group suggested that part of the solution would be to issue repos and reverse repos for at least a week, instead of overnight. Doing so would also help to develop India's credit market, which currently has no benchmark interest rates on public debt for terms of between one day and one year.

The daily repo and reverse repo operations are called the Liquidity Adjustment Facility (LAF).

The group also proposed setting up a Market Stabilisation Fund "for mopping up enduring surplus liquidity from the system over and above the amount that could be absorbed under the day to day repo operations of LAF."

That fund would issue bonds.


FOREIGN RESERVES

The group said that the proposals would be open for debate until December 31, after which the central bank would decide what to do.

The rising scale of foreign investment in India appears in India's foreign exchange reserves, where much of the foreign currency ends up as the central bank buys it to hold down the rupee.

The investment, along with earnings from trade and money sent home by expatriate Indians, has lifted the reserves to a record $95 billion, up from $67 billion a year ago.

The resultant surplus cash in the domestic money market has driven government bond yields to record lows and posed what the central bank called a "short-term liquidity management problem".

The working group also proposed to reduce one of the central bank's benchmark interest rates, the rate it pays on the prudential cash reserves it holds for commercial banks.

Another, the rate at which it refinances commercial bank debt, should be raised to the reverse repo rate of 6.5 percent, from 6.0 percent. Doing so would leave an interest rate "corridor", an unambiguous gap between in which the short-term yields on public and commercial bank debt would fluctuate.

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