I cannot understand the fuss about the interest rate ; the connect between the Key Repo Rate (KRR) and the interbank rates and other money market rates was inexistent. it did not make any difference to existing liquidity conditions if the KRR was raised or reduced because of the persistent prevalence of excess liquidity in the money market.
It is our choice of a model of economic development that is making it more difficult for the money market. The BOM is finding it increasingly difficult to remove the persistent excess liquidity resulting from regular surpluses in the BOP (real estate schemes)( and thus the consequential increase in the monetary base) given that we already have an overvalued exchange rate in a situation of feeble growth and demand in world markets. For the moment it is inconsequential whether we have a low or a high KRR as the money market or interbank rates have been consistently below the KRR.
This gap is making the monetary policy transmission mechanism ineffective and it is the excess liquidity in the market that is encouraging riskier lending. The low rates limit the choices of the Central bank; it has already had its hands full after having recourse to reserve ratio and macro prudential measures and now issuing government securities to mop up the excess liquidity at its own cost, as well as sterilized interventions in the foreign exchange market. So its is not a question of the CB getting concerned now about low interest rate, unproductive investment and savings. Its only choice is to raise the money market rates towards the KRR as excess liquidity dries up and restore the connect between the KRR and the interbank rates for an effective monetary transmission mechanism.
The connect between the Key Repo Rate (KRR) and the interbank rates and other money market rates was inexistent. it did not make any difference to existing liquidity conditions if the KRR was raised or reduced because of the persistent prevalence of excess liquidity in the money market.This gap is making the monetary policy transmission mechanism ineffective and it is the excess liquidity in the market that is encouraging riskier lending. The low rates limit the choices of the Central bank; it has already had its hands full after having recourse to reserve ratio and macro prudential measures and now issuing government securities to mop up the excess liquidity at its own cost, as well as sterilized interventions in the foreign exchange market. So its is not a question of the CB getting concerned now about low interest rate, unproductive investment and savings. Its only choice is to raise the money market rates towards the KRR as excess liquidity dries up and restore the connect between the KRR and the interbank rates for an effective monetary transmission mechanism.
Moreover, as pointed out by an economist friend “Bank credit growth rate has been marginal in nominal terms so no question of riskier lending. If anything, banks have become more risk-averse. Corporates are too leveraged-Cash-flow issues. Until such time that they are able to clean their balance sheets, they won't invest. It is not only a Monetary Policy problem.” Under such conditions Monetary Policy will be like “pushing on a string”.
