MUMBAI, June 13: Signalling the downward movement of interest rates, the Reserve Bank of India (RBI) on Saturday cut the repo rate (interest rates on repurchase of government securities by the RBI) by 100 basis points to 5 per cent. This is the second repo rate cut since the announcement of the monetary and credit policy for the first half of 1998-99. On April 29, the RBI cut the repo rate from 7 per cent to 6 per cent.The central bank has been using the repo rate as the main instrument to signal interest rate movement. The apex bank retains the right to use the fixed as well as the auction system for conducting repos making it the most potent weapon to control markets. This is a sharp departure from the traditional stance when the bank rate and open market operations were used to signal rates.
The repo rate cut is a realisation by the RBI that there is sufficient liquidity in the economy and that interest rates are headed down. The central bank's dilemma is to reconcile its concerns with the stabilityof the rupee with its determination to hold down interest rates. One of the traditional ways to control a currency is changing interest rates, as the RBI did in January. The cut in the repo rate is in conformity with the RBI stance that the system is flush with liquidity and there is no pressure on short-term interest rates.
``Interest rates will not rise after the repo rate cut. The overnight call rates are expected to come down and the six-month annualised forward premiums will come down by 100-150 basis points from the existing level of 10 per cent. The call rates will dip to the new floor rate of 5 per cent and bond prices are bound to go up,'' said a banker.
Dealers said forward premium on dollar has been on the rise as market players were arbitraging between the overnight market and the forward dollar market taking advantage of the low call rates. After the RBI issued a stern warning to banks to stay away from arbitraging, forwards are all set to dip. ``The repo rate cut will only add to therealignment of the rate,'' said a dealer. If the short term interest rate falls to lower levels then there is the danger of excessive arbitrage between the money and forex markets. To ensure that the lower interest rates do not lead to speculation against the rupee, the RBI has already warned banks not to arbitrage between the money and forex markets. However, the RBI does not have a tight control over the banking sector to monitor the arbitrage business.
In the government securities market, the prices across all maturities moved up by 20 to 25 paise. According to dealers, hectic activity was seen in the government securities market on Saturday. Dealers maintained that selling pressure was seen in the gilts market.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
