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Monetary Policy RBI July 2010 Review What is New VRK100 30082010

Monetary Policy RBI July 2010 Review What is New VRK100 30082010

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Rama Krishna Vadlamudi, Hyderabad, has analysed the RBI's first quarter review of Monetary Policy announced on July 27,2010. Reserve Bank of India (RBI) had announced its first quarter review of Monetary
Policy 2010-11 on July 27, 2010. Of late, especially after Mr D. Subbarao took
over as Governor in September 2008, RBI has taken some kind of fresh
approach towards issues relating to Monetary Policy and Indian Economy – right
from taking a lot of bold measures between September 2008 and January 2009
to save the Indian Economy from the aftershocks of sub-prime crisis in the US to
the latest first quarter review. Let us examine what are the important aspects of
this new and fresh perspective in the latest monetary policy review.
Rama Krishna Vadlamudi, Hyderabad, has analysed the RBI's first quarter review of Monetary Policy announced on July 27,2010. Reserve Bank of India (RBI) had announced its first quarter review of Monetary
Policy 2010-11 on July 27, 2010. Of late, especially after Mr D. Subbarao took
over as Governor in September 2008, RBI has taken some kind of fresh
approach towards issues relating to Monetary Policy and Indian Economy – right
from taking a lot of bold measures between September 2008 and January 2009
to save the Indian Economy from the aftershocks of sub-prime crisis in the US to
the latest first quarter review. Let us examine what are the important aspects of
this new and fresh perspective in the latest monetary policy review.

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Categories:Business/Law, Finance
Published by: RamaKrishna Vadlamudi on Aug 30, 2010
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09/18/2010

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Reserve Bank of India (RBI) had announced its first quarter review of Monetary Policy 2010-11 on July 27, 2010. Of late, especially after Mr D. Subbarao took over as Governor in September 2008, RBI has taken some kind of fresh approach towards issues relating to Monetary Policy and Indian Economy – right from taking a lot of bold measures between September 2008 and January 2009 to save the Indian Economy from the aftershocks of sub-prime crisis in the US to the latest first quarter review. Let us examine what are the important aspects of this new and fresh perspective in the latest monetary policy review.
What’s new?
There are four new areas which RBI has focused on in the latest policy review. They are:1. Change in policy Stance; 2. Reduction in LAF corridor; 3. Introduction of mid-quarterreview in addition to quarterly reviews; and 4. Expected Outcomes.
1. Change in Policy Stance:
RBI is deeply concerned about rising prices and double-digit inflation in India andrenewed uncertainty in global economic recovery owing to Greek Sovereign debt crisisand high employment in the US. India’s inflation measured by Wholesale Price Index(WPI) has been more than 10 per cent since February 2010. However, RBI is optimisticabout the India’s GDP growth in 2010-11 reinforced by the good progress of the South-West Monsoon, expansion in India’s exports and imports, and double digit growth in theindustrial production. Taking these into consideration, RBI has increased its projectionfor India’s GDP growth in 2010-11 to 8.5 per cent from 8 per cent projected in its April2010 Annual Policy review.Against this backdrop, the RBI has changed its policy stance decisively to containinginflation and anchoring inflationary expectations.
2. Introduction of mid-quarter reviews:
Till Now, RBI was undertaking Monetary Policy reviews at quarterly intervals in April,July, October and January every year. From now onwards, it will carry out mid-quarterreviews in June, September, December and March; in addition to quarterly reviews. Mid-quarter reviews will be conducted roughly one and a half-month after each quarterlyreview. The rationale behind the introduction of mid-quarter reviews is to inform RBI’sassessment of economic conditions more frequently to the market participants in linewith major central banks, like, the US Fed and the ECB.
 
Rama Krishna Vadlamudi, HYDERABAD August 28, 2010 
www.scribd.com/vrk100 vrk_100@yahoo.co.in
 
MY BLOG: www.ramakrishnavadlamudi.blogspot.com 
Page 2 of 3 
3. LAF corridor shortened:
 
LAF Corridor
Mar.2002Mar.2004Apr.2005Oct.2006Jul.2008Nov.2008Jul.2010050100150200250300350Mar.2002 Mar.2004 Apr.2005 Oct.2006 Jul.2008 Nov.2008 Jul.2010
   B  a  s   i  s   P  o   i  n   t  s
 LAF Corridor is the excess of LAF-Repo Rate over the LAF-Reverse Repo Rate. Beforethe first quarter review, the LAF corridor was at 150 basis points. On July 27, 2010, RBIraised repo rate by 25 basis points to 5.75 per cent and reverse repo rate by 50 basispoints to 4.50 per cent; thus effectively reducing the LAF corridor from 150 basis pointsto 125 basis points (repo rate minus reverse repo rate = 575 - 450). Repo Rate is therate at which RBI charges commercial banks for their overnight borrowings from RBI byexchanging Government Securities. Reverse Repo Rate is the rate at which RBI payscommercial banks for keeping their overnight surplus money with RBI while exchangingGovernment Securities, under RBI’s Liquidity Adjustment Facility (LAF). LAF is amechanism by which RBI adjusts daily liquidity in the domestic money markets byinjecting funds (at repo rate) or by withdrawing them out (at reverse repo rate). Thisoperation is conducted with the help of exchanging Government Securities.As can be seen from the above graph, the corridor was at an elevated level of 250 basispoints (bp), which was brought down gradually to 100 bp in April 2005. From there, itwas gradually widened to as high as 300 bp. Later, during the peak of US sub-primecrisis, this was narrowed down sharply to 150 bp in just three months. Finally, in the firstquarter review of July 2010, this was further shortened to 125 bp.What is the significance of this LAF corridor? LAF corridor is important from theviewpoint of short-term interest rates. Short-term interest rates, usually represented bycall money rates and CBLO* rates, are supposed to move in a range between repo rateand reverse repo rate. Central Banks in general are not comfortable with volatility inmarkets. As such, RBI would use this corridor to contain volatility in short-term interestrates. By narrowing down the difference between repo rate and reverse repo rate, RBIhas expressed its strong desire to contain any wild movements in the call money rates.
(* CBLO-Collateralized Borrowing and Lending Obligation of the Clearing Corporation of India Limited. It is amoney market instrument through which CCIL imparts liquidity to market participants.)

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