RBI policy will reduce volatility — Reddy

for 2000/01 announced on Thursday left key interest rates unchanged, since they had been cut at the start of the month, but said the cash reserve ratio, currently at eight percent, would be reduced as and when required.

Among structural changes in the debt and money markets, the RBI announced the gradual introduction of an auction-based liquidity adjustment facility to replace the assured levels of refinance available to banks and primary dealers.

The central bank said banks need to maintain only 65percent of their CRR as daily minimum balance from May 6, against the earlier 85 percent.

"Our assessment was that asking them to maintain 85 per cent everyday was resulting in volatility and we will be able to reduce volatility by reducing the daily requirement of 65 percent," Reddy said. Money markets currently operate in a fixed interest rate corridor benchmarked to the RBI’s repo and refinance rates.

Reddy said by moving to auction-based funding, the markets will with time operate entirely through three markets — the repo market, the inter-bank call money market and the RBI’s repos and reverse repos.

He reiterated that the central bank’s policy stance on interest rates was neutral.

"I wouldn’t call it easy or tight, but operating through liquidity to accommodate both credit needs and maintain price stability," the deputy governor said. The RBI policy said the government’s high borrowing of 1.17trillion Rupees ($27 billion) in 2000/01 could pose a challenge and it had to ensure favourable interest rates for industrial recovery.

"I think the policy has clearly stated the preference of the RBI, the enabling environment created and the rigidities in the system that determine the interest rate positions," Reddy said.

"On the reduction in reserve ratio, it has been indicated that our preference is to move in that direction, that’s the medium term objective. When and how much will be determined by the monetary and fiscal situation," he added. "The important thing for Financial sector reform is the reduction of CRR so that both banks and non banks will have a level playing field in Financial intermediation."

Reddy said market fears of a likely tightening of rates during the year may be based on the policy statement, but the central bank was deriving comfort from the country’s strong position on the supply side.

"…What the monetary policy says is that in case of pressures on the demand side, tightening may be required."

The RBI policy eased some lending and deposit norms for banks, and said changes in prudential norms will be announced later. "What we are trying to do is to encourage the competitive pressures on the banking system and give greater freedom to operate without sacrificing prudential requirements," Reddy said.