Need better monetary policy transmission: Reserve Bank

In its annual report, the Reserve Bank of India (RBI) has said the efficacy of the monetary policy transmission mechanism needs to improve, as the pass-through of recent cuts in policy rate to the bank lending rate has only been partial. Though RBI has cut the repo rate (at which banks borrow from the central bank) by 75 basis points since the beginning of this year, banks have been reluctant to reduce lending rates.

According to RBI, the partial transmission reflects constraints under the existing base rate system. “Identifying the impediments in pass-through and implementing an alternative method such as marginal cost-based credit pricing or identifying an appropriate benchmark for the bank lending rate will be a priority for the Reserve Bank,” the central bank said.

The report also stressed how it was crucial to develop market-based benchmarks by developing the term segment of the money market. “Liquidity support may have to be progressively provided through regular auctions of longer-term repos, with reduced dependence on overnight fixed-rate liquidity support,” it said. The regulator believes while doing so, it will be important to restrict deviations of overnight rates such as the weighted average call money rate to a narrow range.

NEED FOR CHANGE

• The pass-through of recent cuts in policy rate to the bank lending rate has only been partial
• Partial transmission reflects constraints under the existing base rate system
• Monetary policy has been focusing on fostering a gradual and durable disinflationary process
• Wide gap between the CPI and the WPI has been a challenge for monetary policy communication

In the recent past, it has been observed that overnight rates fell below seven per cent due to ample liquidity in the system. Following three 25-basis-point cuts since the beginning of this year, the repo rate now stands at 7.25 per cent.

RBI’s monetary policy has been focusing on fostering a gradual and durable disinflationary process to achieve the inflation target of less than six per cent by January 2016 and the government-projected rate of four per cent by the end of 2017-18.

Consumer Price Index (CPI)-based inflation fell to 3.78 per cent in July from 5.4 per cent in June, while Wholesale Price Index (WPI)-based inflation was in negative territory (-4.05 per cent). The wide gap between the CPI and the WPI has been a challenge for monetary policy communication.