Markets more uncertain now, says Reddy

The Reserve Bank of India (RBI) has said the 250-basis point spread between the repo and the reverse repo rates reflects a heightened level of uncertainty in financial markets.

"A dynamic balance (between the use of liquidity and interest rate instruments) is evident from the spread between the repo and reverse repo rates, which is enlarged during times of uncertainties.

It has moved from 150 basis points to 100 basis points when times were good and has now moved to 250 basis points, reflecting greater uncertainties," RBI Governor Y V Reddy said in his remarks at the annual general meeting of the Bank of International Settlements (BIS) on Saturday. The governor's remarks were made public today.

Repo is the rate at which RBI lends to banks under the Liquidity Adjustment Facility (LAF), while the reverse repo is the rate at which it borrows from the banks. In recent times, RBI has only increased the repo rate without changing the reverse repo rate in a message to the markets that interest rates should be enhanced to combat higher inflation.

In June, RBI raised the repo rate by 75 basis points to 8.50 per cent. This year, it also increased the cash reserve ratio (CRR), or the proportion of deposits that banks have to set aside, by 125 basis points, with the latest revision of 50 basis points announced last week.

While RBI has been using various instruments at its disposal to lower inflation, which touched 11.42 per cent in early June, Reddy said market participants should be willing to share some costs of uncertainties.

In addition, the said governor said, the central bank had been using regulatory policies to supplement monetary measures and pointed to the increase in risk weights and provisioning requirements for bank exposure to real estate, consumer loans, capital markets and non-banking finance companies.

While maintaining that the Reserve Bank did not take a view on asset prices, the governor said the idea was to protect the banking system from risks and cited changes to the accounting norms to deal with housing markets in India that are illiquid.

He said: "When there is all-round prosperity, everyone wants everything to be left to the markets; when things go wrong and there is pain, monetary and regulatory policies are invoked to save the situation."

Reddy said RBI had been taking pre-emptive measures since 2004. He said to deal with out-of-the-ordinary situations "exceptional or flexible arrangements are needed". "This helps in avoiding more serious problems relating to the balance over the medium-to-longer term," he said, while pointing to the recent special windows aimed at easing the liquidity situation for oil companies, which were selling bonds in the markets at a discount to meet the higher import bill on account of a steep rise in crude prices.

To keep forex rates steady RBI also opened a special window for oil firms.