The standard explanation that comes through the central banking sources is that the CRR reduction is aimed at increasing the liquidity in the banking system over a long period of time while the repo auction is timed to reduce the excess liquidity from the money market in the short term, so as to ensure that the call money segment does not become unviable.
Varying perceptions
A fact that RBI sources do accept is the fact that such dual purpose policies bring about disruption in the money market, particularly through their impact on liquidity perceptions among the market players and thereby through interest rates. This partly explains the rapid variations seen at the 91 day treasury bills auctions held by the RBI every week. According to a primary dealer, the perception of the players regarding short term liquidity is changing from week to week, and so is their response to the auctions. At times, they perceive the liquidity in the system to go down, and therefore their response to the auction is lukewarm. At other times, the liquidity perception is high, and the market response turns out to be excellent.
A similar situation prevails in the call money segment too. The interest rates in this short term market have been fluctuating in the recent months to as low as 0.2 per cent on the down side to 12 per cent and more on the upside. And last year, the rates went up to more than 100 per cent. Notwithstanding the comparatively smaller fluctuations in the last few months, the market players believe that it remains prone to violent ups and downs.
Since the beginning of the current financial year, the RBI has been trying to bring about a reduction in interest rates through its auctions and other open market operations. As a result, short term rates have declined from 10.35 per cent at the beginning of the year to 8 per cent now, says K V Hegde, managing director, Gilt Securities Trading Corporation, a Canara Bank subsidiary and one of the six primary dealers operating in the market. But the long term rates are apparently more sticky: they have only declined from 13.10 per cent to 12 per cent. And this gap leads to differing perceptions of liquidity in the market.
This in a nut-shell personifies the current dilemma of the money market. And though the RBI tries hard to rectify the situation, the market perception of the hiatus remains firm. Apparently, the two sets of interest rates are being governed by different set of factors. And this phenomenon vitiates the liquidity and interest rate perceptions of the players.
The long and short of the matter
While the long term expectations are built around factors like fiscal deficits and inflation, short term factors are different. The short term interest rates are being governed by the temporary surpluses and shortages in liquidity in the money market, explains one of the money market dealers. The RBI through its regular weekly auctions of treasury bills tries to influence the market rate of interest. But its success rates show a wide degree of fluctuations. On rare occasions it manages to sell off the full amount of the 91 day treasury bills it puts on the block, on other occasions it has to face devolvement as the expectation of the market in the matter of yield is at variance from that of the RBI.
What explains the sharp differences in interest rate perceptions? One of the reasons is that the system has only been partly deregulated, according to Hegde. Another reason is the lack of a reference rate in the Indian system. There is no single interest rate which may be treated as a standard rate around which other rates can converge, he adds. Abroad, the most widely-accepted and representative rate is the Libor. Some attempts which were made to evolve such a rate in India have met with failure because they were not encouraged by the RBI, say market sources.
In need of a benchmark
And the absence of a reference rate is apparently due to the absence of an interbank term money market, they point out. The 91 treasury bills set out interest rates for a period up to three months, while the 364 day treasury bills do so for longer period of up to one year. However, for the intermediate period, there is no reference rate. So a player with surplus funds for say 60 days finds it difficult to decide on the interest rate he should get for this period. Though the inter-corporate deposit market avenue is available, the risk here is too high,and not every one would want to invest there. In this situation, there is a gap in the yield curve which is therefore not smooth and even, says a dealer.
In fact, some of the bankers even question the existence of a yield curve in the current scenario. A properly determined rupee yield curve does not exist as there is no interbank term money market at present, says G Shiva, vice president, Citibank.
And a major reason for the absence of an inter bank term money market is, according to banking circles, the imposition of CRR on interbank deposits. There are lenders willing to take a view for a period of 6 to 9 months, but there are no borrowers for this period as they would be subject to CRR, says Vishnu Deuskar, country treasurer at ABN Amro Bank. The RBI, however, has its own logic to continue with it. When deposit moves from one bank to another, it is removed from the books of the former and entered in the books of the latter, so what is the justification for removing CRR on them, asks an RBI spokesperson.
However, the imposition of CRR on interbank deposits is not the only reason that has prevented the evolution of a reference rate in the money market. Multiplicity of interest rates and costs is an important contributory factor, says Shekhar Sathe, senior vice president, Kotak Mahindra Capital. And this is despite the fact that the RBI has tried to reduce the number of rates in the economy. The compartmentalisation of the markets has led to the multiplicity of rates, he explains. You have players like banks, financial institutions, NBFCs, PSUs and private companies in the market. Some of them may have identical ratings, but the interest rate they command is different, he points out. That is because the assets and liabilities side in each case is different, and there are artificial restrictions on them, adds Sathe. And though all of them have a deposit base, the reserve requirements for them is different.
And what is the impact of the absence of a reference rate in the money market? In addition to leaving a vacuum for an anchor rate, which leads to wide fluctuations in the money market, it also has other repercussions. The asset pricing function becomes extremely inefficient in the absence of a reference rate, says Hegde. Others agree with him. The absence of reference rate makes determination of asset prices difficult, as one does not know if the security price is undervalued or overvalued, points out G Shiva, vice president, Citibank.
Moreover, hedging of interest rate exposures for market players also becomes difficult in the absence of a reference rate, according to Shiva. Hegde too concurs with this view. And these kind of facilities are necessary for the markets to mature.
Both the market players and the authorities recognise that there is a need for a reference rate around which the call rates and the secondary market prices of securities can align. The absence of a reference rate brings about more volatility in the market as short term demand and supply factors tend to govern the market instead of long term interest rate expectations, points out Shiva. Such a rate will also help the integration of capital, money and forex markets, as money is totally fungible and should be able to flow freely between different market segments, according to Hegde. Term money market and a reference rate will help even out the market fluctuations by providing an anchor to market expectations. Once the RBI removes the CRR on inter bank deposits, a term market would automatically evolve, along with a reference rate, says Deuskar. What all players agree upon is that the emergence of a reference rate will lead to more stable and efficient money market.
