Market-Driven Reference Rate Needed

The Reserve Bank of India (RBI) is promoting its key Bank Rate to signal interest rate changes but analysts said yesterday a market-driven benchmark rate is needed for truer pricing of debt instruments.

They said they were hoping a forthcoming policy statement from the RBI will include some measures to help the moribund term money market take off. This market would provide a benchmark interest rate which could be used to price debt instruments.

The RBI announces its credit and monetary policy for second half 1997-98 on October 21 amid widespread expectations it will cut its Bank Rate by 0.5 to 1.0 percentage point from the current 10 per cent.

The RBI's Bank Rate is the rate at which banks borrow from the apex bank and changes in the rate are seen as a signal on which way banks' interest rates should move.

The RBI, in its last credit policy, announced in April, said it wanted to establish the Bank Rate as a reference rate.

Interest on deposits with a maturity from 30 days up to one year and central bank refinance are linked to the Bank Rate. But in the present liquid conditions, banks are not drawing refinance from RBI, diluting the effectiveness of the Bank Rate.

"A market reference rate is a must if debt is to be priced correctly," said Aashish Pitale, debt research analyst at ICICI Securities and Finance Com-pany (I-Sec). "At the moment, pricing is pretty arbitrary."

Interest rates vary widely in India's imperfect markets. Blue chip corporates raise money through three-month commercial paper at around 8.5 per cent while the lowest commercial bank prime lending rate is 13.5 per cent per annum.

Rates in the inter-corporate deposit market, where companies borrow from each other, are currently at 12.0-13.0 per cent per annum for three month deposits.

The government for its part, raises money through 91-day treasury bills at 6.9 per cent while three-month certificates of deposit issued by banks range from 8.0 to 9.0 per cent per annum.

Integration of yields on different sources of funds will enable more efficient allocation of resources and give corporates a wider choice among alternate sources of funds, the RBI said in its annual report for 1996-97 (July-June).

"The RBI wants to promote its Bank Rate as a reference rate but if it is to be a real benchmark, it has to be market-driven, not set by the apex bank," said a banking analyst at a US brokerage who asked not to be named.

He said the RBI's Bank Rate was the equivalent of the Federal Reserve's discount rate but what was needed was a market rate like Libor.

The interbank term money market, which could have provided a reliable benchmark, remains stillborn despite efforts by the RBI in the last credit policy to start it up by removing cash reserve ratio requirements on interbank borrowings.

"A lot of this has to do with bankers' competence," said a dealer at a private bank. "To start with, you should have the ability to take a view on interest rates," the dealer said. "Most of the market players do not seem to have the ability to take such views." (Reuter)

"Then you have to fix exposure limits for parties (from whom to borrow or lend) and there are also capital adequacy requirements," he said.

The nearest to a benchmark rate in India at present is the Mumbai Interbank Overnight Average Rate (Mibor) for call money. This is a composite weighted average of trades done by 15 banks and financial institutions.

But dealers say the rate is yet to gain wide market acceptance and be used as a reliable benchmark. They say there is a need for a reference rate applicable to longer periods.

P S Subramanyam, executive director of Industrial Development Bank of India (IDBI) told a debt market seminar yesterday the pressing need was for a benchmark term money rate. "A proper reference rate will help in pricing swaps and develop a swap market," I-Sec's Pitale said. "At the moment, banks have fixed rate liabilities (deposits) and floating rate assets (loans) and are exposed to interest rate risks," he said. (Reuter)A market reference rate is a must if debt is to be priced correctly.

At the moment, pricing is pretty arbitrary. Aashish Pitale analyst 1-Sec