The YoY increase in RBI refinance to banks stood at Rs 4,868 crore as on January 1, 1999 -- an increase of 76 per cent. The increase in the level of RBI refinance to banks outstanding as on July 31, 1998, before the lowering of the refinance rate works out to 105 per cent, all within the span of just five months.

The strangest thing about this increase in the quantum of RBI refinance is that it is occurring at a time when exports have not been increasing. During the eight months ended November 1998, exports declined by 4.5 per cent.

Says Standard Chartered Bank's head (trading)Janak Desai, "It is quite puzzling. It could, in part, be explained away by the fact that there could be an arbitrage going on between the repos window and refinance availed of from the RBI. It is hard to monitor any such arbitrage, that is, assuming it is happening in the first place".

The low RBI repos rate does, indeed, provide for a clear arbitrage opportunity.

Given the repos rate at 8 per cent and export refinance rate at 7 per cent, the RBI is, in effect, accepting money from banks at 8 per cent while doling out funds at 7 per cent. For banks, this is a bonanza, and export refinance is availed of by them whenever call rates rule over 7 per cent. The high repos rate provides a floor to the call rate and explains why banks have taken so much refinance form the RBI.

While general refinance too is part of the total refinance which banks obtain from the RBI, the bulk of the refinance availed of is export refinance. In October, for example, while general refinance drawn was only Rs 76 crore, exportrefinance was Rs 5,524 crore.

Says HSBC's manager, trade services, Kersi Patel, "While exports may have fallen in dollars, they are up in rupees by about 6 per cent to 7 per cent. And banks had in the last fiscal opted to refinance exports out of call borrowings rather from RBI's export refinance counter at 8 per cent. The trend has shifted this year, and this is the reason for the increase in export refinance," a view shared by Bank of India's (BoI) executive director R Gopalakrishan.

With the growth in export credit refinance accounting for 13.8 per cent of the increase in reserve money, economists say that closing of this arbitrage opportunity to banks, by either reducing the repo rate or increasing the export refinance rate, would enable the RBI to cut down the spurt in M3 growth. Standard Chartered Bank's Desai echoes this point when he says that "there is a general feeling in the market that a realignment of rates... between export refinance and repos rate, may be warranted at this point intime".

This would also be in order since the increased refinance has obviously not led to exports growth. As BoI's Gopalkrishnan says, "It is time that the export refinance rate is linked to actual performance at this end rather than as is currently, at subsidising costs to banks, and that too for only a portion of their total export portfolio. Concessional export refinance should cover exports in toto."

This is reflected by the fact that banks have been unable to draw upon the refinance to the extent they would have liked to because of the decline in exports, borne out by a slowing down in the rate of increase in refinance.