9/12/2017

Money,Forex andBondMarkets
I.Money&MonetaryPolicyTransmission

Dr HKPradhan
XLRIJamshedpur

FinancialMarketInteractions
Bankbasedvs CapitalMarketbasedsystem
Savings,financialintermediation,credit
informationandeconomicgrowth
Fiscalandmonetarypolicyinteraction,
Monetarytransmissionmechanisms
Capitalflowsandexchangerateregimes
Innovativeinstrumentsincapitalmarkets
Arbitrageconditionsandpricingefficiency
Microstructurerelatingtotrading,liquidity,and
transactioncosts

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PolicyObjectives
Monetary Fiscal
Objectives Objectives
Growth,employments, Pricestability,growth,
distribution,poverty financialstability,external
reduction,macroeconomic
balance balance
Instruments/targets Instruments/targets
Moneysupply Tax
Interestrate Expenditure
Exchangerate
Subsidies
Capitalcontrols
Bankingregulation& Publicdebt
supervision Convertibility

PolicyEvolution
Priorto1992 CharacterizedbyAutomatic
Monetisation (AdhocTbills),DirectedInvestment,
AdministeredRates
Fiscal&MonetaryPolicypost1992:AbolitionofAd
hoctreasurybills(1994),InstitutionoflimittoWays
andMeansadvances(1997),ReductioninStatutory
LiquidityRequirement(38.5%to20%)
TheFiscalResponsibilityandBudgetManagement
Act,2003,stipulatingfiscaldisciplinewithfiscaldeficit
3%ofGDP,totaldebt9%ofGDP,theCentral
GovernmentshallnotborrowfromtheReserveBank
ofIndia(RBI)exceptunderexceptionalcircumstances

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RBIoperatesbothasthemonetaryauthority
andthedebtmanagertotheGovernment
MonetaryAuthority(monetarypoliciesforpricestabilityand
liquiditymanagement)
RBIAct,1934,amendedeffectedonJune27,2016accord
primacytoinflationasthegoalofmonetarypolicyinIndia,
whilekeepinginmindtheobjectiveofgrowth.
AMonetaryPolicyCommittee(MPC)wasconstituted,to
setoutinthepublicdomaintheoperatingprocedure
Facilitatesgovernmentdebtoperationssothatgovernment
financesatleastpossiblecosts,withoutfinancialmarket
disruptions
ThePublicDebtAct,1944,replacedbytheGovernment
SecuritiesAct,2006,providedalegalframeworkforthe
issuanceandservicingofgovernmentsecuritiesinIndia
RBIisthecustodianofgovernmentsecuritiesandmanages
itsissuancesandredemptionsaspertheAct

RBIRole
Tobalancetheneedsofthemarkets(manageliquidity),
Tofacilitategovernmentfinancing(fiscalrequirements),
Themitigateanyadverseimpactonthebalancesheetsof
thebanks(assetpricesandinterestratemovements),
Toensurestabilityinthegeneralpricelevel(growthof
moneysupply),
Therebyensuringgrowth&financialstabilityinthe
mediumrun
Maintainfunctionalseparationbetweendebt
managementandmonetaryoperationsbytheRBI
Economicpolicymakingcoordination:procyclicalversus
countercyclical

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RespondingtoGrowthCycles

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MonetaryPolicy
Afterall,monetarypolicyistomanagemoney
thatareinthesystembywasofcash&credit
Bychangingmoneysupply(credit,interestrate,
liquidity)
Example:ariseininterestratesmayleadtothe
following:
Demandforloanscomedown
Assetslosevalue
Firmsreduceinventories
Aggregatedemandiscontracted

Demonetization&CashEconomy

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PolicyCoordination
Roleoffiscalpolicyisalsoimportant,avoidingexpansionin
aggregatedemandandcrowdingoutprivateinvestments
(Wehadperiodsoffiscaldominance(automaticmonetization
offiscaldeficits)
Tradeoffs:Inflation,InterestRates&realexchangerates,Growth&
Employment
Inthepresenceofsupplyshocks(oilpriceshocks,foodinflation)
someinstruments(suchasinterestrate)maynotwork
Incontrollinginflationhowtodealwithsupplyshocksisa
challenge
Maintainingrealexchangerate,therebycompetiveness,isequally
important
Coordinationofdebtmanagementandmonetarypolicyimportant

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MonetaryPolicyInstruments
Moneymarketthefocalpointforliquidity
management Asof9August2017,the
LiquidityAdjustmentFacility(LAF) keyindicators:
RepoandReversereporatedefinesthecorridor Indicator rate
Primaryinstrumentsofinterestratesignaling
Primaryinstrumentofmanagingdaytoday Inflation 2.33%
liquidity CRR 4%
OpenMarketOperations(OMO) SLR 20%
Reporate 6.0%
Secondaryinstrumentsofmonetarypolicy
Reversereporate 5.75%
Outrightpurchases/salesofGSec MSFrate 6.25%
MarketStabilisation Scheme(MSS)
toabsorbliquidity,particularlyofmore
enduringcapitalflows
BankReserves:theoperatinginstrument
CRR,SLR
Tinbergenrule:thereshouldbeatleastthesamenumberofinstrumentsas
therearetargets (e.g.inflationcontrolrequiresinterestratecontrol)

RBI,AnnualReport2017,page89

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RBI,AnnualReport2017,page89

OperatingMechanisms
Urjit Patelcommitteereport:
https://rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=743 )
MonetaryPolicyCommittee:Inflationtargetingframeworkis
nowalawinIndia
CPIHeadlineorCPICoreInflation
WPIisinfluencedbyglobalfactors,itdoesnothaveservices
CPIHeadlinecontainOilandFoodprices,whereRBItargets
4%+/ 2%

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MonetaryPolicyOperatingFramework:
Chanel1(Interestratechannel)

RBI,AnnualReport2017,page88

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GOI,EconomicSurvey201617,Page26

GOI,EconomicSurvey201617,Page109

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https://craytheon.com/charts/rbi_base_rate_repo_reverse_rate_crr_slr.php

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RBI,AnnualReport2017,page59

GOI,EconomicSurvey201617,Page165

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RBI,AnnualReport2017,page61

GOI,EconomicSurvey201617,Page32

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7.00 8.00 9.0% 22.5

% % %

WhereisLiquidity

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ImportanceofLiquidityManagement

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RBI,AnnualReport2017,page35

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GovernmentCashManagement

Cashmanagementoptions
Treasurybills
Waysandmeans
advances(WMA)
CashManagementBills
Repo/ReverseRepo

BaseratetoMCLR
RBIdecidedtoshiftfrombaseratetomarginal
costoffundsbasedlendingrate(MCLR)forfixing
interestratesforadvanceswitheffectfromApril
1,2016(Refer
http://www.arthapedia.in/index.php?title=Margi
nal_Cost_of_funds_based_Lending_rate_(MCLR)
Marginalcostoffunds=(92%xMarginalcost
ofborrowings)+(8%xReturnonnetworth)
Theactuallendingratesaredeterminedby
addingthecomponentsofspreadtotheMCLR

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RBI,AnnualReport2017,page91

RBI,AnnualReport2017,page91

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Whybanksdontpassonthelower
interestratestoborrowers?
Banksabsorblowerinterestratesintheir
margins,astheyarealreadystressed
Banksalreadyhavehighcostofpastdeposits,so
currentlowratesarenotpassedon
Thereisnosymmetryofpassthroughduring
risingorfallingrates
Lowerlendingratemaynotincreasecredit
growthasinvestmentclimatemaynotbegood
Bankscanstillaccepthigherdeposits,andinvests
inlongtermgovernmentbonds

LiquidityCrisis:July2013
15/07 16/07 17/07 23/07 24/07

WeightedCallRate 7.21 8.53 7.99 7.14 9.94

2monthCD 7.55 10.35 9.75 9.50 10.5010.75

9.50 10.75
MarchCD 8.20 9.90 10.0 9.75
9.45 9.9510.00
1YrCD 8.30 9.90 10.0 9.75
10.46
1YrTBill 7.56 9.10 8.85
8.35 8.60
10YearGsec(8.15) 7.66 8.18 8.16
8.17 8.42
New10YearGsec(7.16) 7.55 8.07 8.05
9.70 10.00
3YrAAA 8.70 9.50 9.6075
9.65 9.90
5YrAAA 8.75 9.60 9.609.75
9.35 9.60
10YrAAA 8.75 9.52 9.459.50
59.765 59.12
INR 59.90 59.31 59.35

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Plot of the Estimated ZCYC

9-Jul-13 10-Jul-13

8.15
8.10 8.10

8.05

7.98

7.95
Spot interest rates

7.85
7.83

7.75

7.65

7.55

Maturity (years)

July2013:RBIrespondingtocrisis
theReserveBanktook severalmeasuressincemidJuly2013,
which,include:
(i)hikeinMarginalStandingFacilityrate/BankRate;
(ii)restrictiononbanksaccesstofundsunderLAFrepo;
(iii)OMOsales;
(iv)maintenanceofminimumdailyCRRbalancesbySCBsat99per
centoftherequirement;
(v)cappingofPDsaccesstoLAFat100percentoftheirindividual
netownedfunds;and
(vi)restrictionsongoldimport.

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MonetaryPolicyTransmission
Channel2:CapitalFlowsandExchangeRate
Inaworldofhighcapitalmobility,itbecomes
difficulttopursueindependentmonetary
policy
Bothdomesticinterestratesandexchange
ratesimpactcapitalflows
Highercapitalinflowsareare monetized,
createsliquidityglut,inflation,requiring
stabilizingrole
Costsofsterilizationofreserveinflows

GOI,EconomicSurvey201617,Page27

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RBI,AnnualReport2017,page6668

RBI,AnnualReport2017,page79

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MonetaryPolicyTransmission
Channel2:CapitalFlowsandExchangeRate
ImpossibleTrinity:Countrycanhaveany
twotargetsbutleavethethirdone

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Long-term interest rates

30

26

22
Percent

18

14

10

2
1970 1974 1978 1982 1986 1990 1994 1998

Ireland Denmark Spain Portugal

Sweden Finland Austria

MonetaryPolicyTransmission
Channel2:SavingsChannel

Theremaynotincreaseinsavings,butreallocationfromrealsavingsto
financialsavings

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Maintainingbalanceisdifficult,ifnot
impossible

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ThankYou

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