RBI’s Intervention in the Money Market

Money market in India was at a nascent stage up until 1990 when liberalization was formulated by the
then finance minister Dr. Manmohan Singh. For the sake of context, consider the fact that only
interbank call market was available as tool for monetary intervention till 1971. The government
administered interest rate didn’t allow indirect ways of monetary policies and necessitated the use of
direct instruments in quantum way where CRR. The underlying theory that monetary policy gives out
signal for future, but the pre 1990 era direct monetary policy made money market a spillover effect and
rendered it ineffective especially the open market operations (OMO). With Fiscals getting out of hand,
liberalization (1990) has allowed Indian money market to flourish and rather than quantum, indirect
ways of maintaining stability of price and short-term Interest rates are being followed.

RBI uses standing facility or refinance and Liquidity Adjustment facility (LAF) as two major ways to
maintain liquidity and price stability in the money market. Commercial banks can borrow from discount
window against collaterals like government securities and any other eligible papers. Commercial banks
could borrow certain percentage of the loans given to specific sectors. It was used as an instrument
where it could encourage or discourage lending through this credit’s varying terms and conditions.

Bank rate was used as the go to instrument to signal policies, but it has been replaced by repo and
reverse repo rates where through a repurchase agreement, the commercial banks can lend 1% of NDLT
from RBI with government securities as collateral. This can be understood in terms of money flow,
suppose there is low amount of money in SLR and CRR, then repo could be used to maintain or if more
growth is targeted and in turn low unemployment, repo can be decreased for bank to have more cheap
funds available which due to competition will result in low interest rates and hence liquidity with high
availability of money, and to halt high inflation, these repo rate can be increased to stop available
money and drive the interest rates up.

In the year 2011-12, RBI introduced Marginal Standing Facility, where only commercial banks can take
loan up to 1% of NDTL above and over repo to maintain liquidity if such crunch situation arises. But no
additional securities were needed, SLR and CRR ones were deemed to be enough. This was charged at
repo + x% interest rate. This x is revised time and again and at present day, its 0.25 against 1 at
announcement. Due to relatively evolved money market, RBI has been able to take OMO and mix of
direct controls to make prices stable, liquidity, growth and overnight rate. Compare for instance 38% SLR
vs 19.5% required now, this alone signals the change in MO of RBI monetary policy and intervention.

Business also need to lookout for such signals to make decision of financing. With repo increasing,
monetary signal would be very clear that the leverage is going to get costly and reliance on debt should
be scrutinized. It would also indicate that liquidity is going down. With the option of standing
option/refinance, some sectors in debt distress can be relieved to some extent and businesses must be
informed and ready to make such moves. A whole lot of economic activities depends on intervention of
RBI and more importantly, correct interpretation of such signals. Businesses ready for such situation
already will have some competitive advantage.