Normalisation of Monetary Policy Continuing

INDIA - In Brief 07 Oct 2013 by Ajay Shah

RBI had embarked on a messy interest rate defence of the rupee where the 91-day rate moved up by as much as 400 bps. After Raghuram Rajan took charge as Governor, some small steps were taken in normalisation.Today, the next step in normalisation took place. RBI cut the marginal standing facility (MSF) rate by 50 basis points. This took the rate from 9.5 percent to 9 percent. This is good news for the equity market and for banks.Liquidity conditions have remained tight since the rate hike as the borrowing from the repo window was also restricted in the mid-July move and the MSF became the operational monetary policy rate. It was been eased by 75 basis points with the credit policy announcement in late September and has now been eased further. This is a step in the right direction as it would move it towards 8.5 which would bring it to 100 basis point above the repo. The repo currently stands at 7.5.An RBI committee headed by Deputy Governor Urjit Patel is working on establishing a new monetary policy framework. Until the committee makes its recommendations and a new framework is put in place, one may expect that the RBI will move back, albeit slowly, to the framework that existed before mid-July where the repo was the policy rate and the MSF was 100 basis points above it and the reverse repo 100 basispoints below it. However, since the borrowing window for the repo is still restricted to 0.5 percent of the net liabilities of banks, Governor Rajan's announcement to make the repo rate the policy rate will become operational only when the restriction on the borrowing limit is eased.We believe that the interest rate cut will not impact the rupee adversely. While in principl...

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