RBI’s Discussion Paper on new private banks needs to be commended for being wholesome. It takes one through the history of new private banks that came into existence after 1992 and highlights that only few have survived and grown. The report has opened the debate by clearly spelling out the pros and cons of the entry norms for enabling the reader to take an informed view. However, the broader question is, what are we trying to achieve by having more private banks?
Theoretically, more players enhance competition which delivers superior results. So, let us look at what could be the other motivations behind this move. The first argument is that we need to have more branches. But, India already has a network of 82,511 branches as of December 2009, which is one of the largest in the world. Besides if branches were the main issue, the existing banks would have opened more in case it made economic sense. In fact, today, 63% of bank branches are in the rural and semi-urban areas with 39% being in rural areas. Therefore, more branches in rural areas cannot be the overriding objective. Will we end up having more branches in the high business centres?
The second is that banking should be more inclusive and, therefore, more banks make sense. There are two aspects here. The first is that today 23% of deposits and 18% of credit are attributable to the rural and semi-urban areas, with rural regions having a share of around 9% and 8%, respectively. Clearly, they are under-banked and given the high share of branches, the business emanating is disproportionate. Will more banks channel efforts on deposits and credit to these regions? Today, the MFIs are trying to enable credit at levels that banks cannot reach. These are not just the unbanked people but also probably the un-bankable ones. New private banks starting off, would not find this ground too fertile to tread.
The second aspect of inclusiveness is the reach to small borrowers. RBI’s data on this is quite revealing. Of the 1,069 lakh accounts that are on the books of banks, 36%—less than Rs 25,000 —have a share of 1.9% of total credit, while another 53% (loans between Rs 25,000 and Rs 2,00,000) have a share of 11.8%. Curiously, 0.2% of the total loan accounts are over Rs 1 crore, account for 58% of total outstanding credit. These numbers illustrate that bank credit is skewed in favour of higher loan amounts, which in turn have a strong metro centre bias. Commercially speaking, these are the big ticket assets that earn good revenues and are easier to monitor than small loans. The question is whether the new banks will risk going for these small accounts?
The third outcome of having more banks could be getting in new products, as was the case in 1993-94 when new private banks were established. The answer here is that this would not be the case as the Indian banks today are at comparable global standards. We cannot think of more products being offered on account of these new banks.
The fourth angle that can be examined is whether the cost of banking will come down? One cannot be too sure here as the addition of a couple of new banks may not make a difference. In fact, banking today is not exactly customer friendly with banks charging for every service—including making use of the branch. In this situation, customers may not really gain. Therefore, more banks and branches will not really increase the comfort level of customers.
On the flip side, anecdotal experience shows that most of the new banks had either lost interest and sold out to others or worked on unsustainable models. Is there any guarantee that they would continue to be in business in the long run?
Is there room for more banks? Sure there is, as the ratio of bank business (defined as sum of credit and deposits) to GDP has increased sharply and continuously from 57% in FY05 to 124% in FY10. This is a good sign as we can see the market grow though it may not be more of the same.
Therefore, the idea of new banks, though laudable, should not be interpreted as a requirement beyond the contours of fostering competition. This would give an opportunity for various business houses to make new forays or financial services providers to convert to a bank—just like the development banks of yesteryear did. More banks will mean more branches and ATMs, though not in the unbanked areas. And maybe some more M&A activity at a later date.
Friday, August 13, 2010
Monday, August 9, 2010
A future where inflation is hedged: Mint: 5th August 2010
We need to protect against price rise. How about a futures contract on the Wholesale Price Index?
Inflation remains a major concern today; it’s certainly preoccupying members of India’s Parliament these days. While prices of some commodities can come down at some point of time, the problem is they can get volatile any time. For that, we need a hedge against inflation. There is at present no such hedge available; whether, say, stock indices or interest rates can act as effective hedges has not yet been established. So is there a more direct way to protect against inflation?
The answer is yes. We have the Wholesale Price Index (WPI), which is reported partly every week for some components, while there is a monthly number for the entire index. So we can quite easily have futures on the WPI. A future is a contract to buy something at a preset price, specified today, in the future.
There are two issues here. The first is how these contracts would be structured. The second is the regulatory part which is, admittedly, a tricky subject.
Just as we have Nifty futures traded on the National Stock Exchange—a contract where the seller pays the buyer if the Nifty hits or crosses some level, allowing the buyer to hedge his underlying stock bets—we can have futures trading on the WPI and its components. Unlike the Nifty, which changes every moment and constantly influences bids on the Nifty futures, the WPI will change every week or month. A call on the WPI futures would be based on a subjective conjecture on where the index will be during the settlement date. Hence, in August, someone can take a call on the WPI October futures contract.
We can have a contract size of 500 WPI indices, which will be valued at around Rs125,000 (500 multiplied by the WPI level, currently around 250). Based on the historic volatility of the WPI, the margin would be 5-10% depending on the index (or sub-index) chosen. Hence, an individual with an initial margin of, say, Rs12,500 (10%) can buy one WPI futures contract. For every 1 percentage point increase in the index in the futures market, the trader going long—betting on the index to rise—would be hedged with a gain of Rs1,250 on a single contract.
The contract will be non-deliverable, like Nifty futures, and would hence have no other obligation (unlike the commodity futures market, where there is physical delivery of the underlying commodity). The settlement price would be the actual WPI level for the contract—the seller will pay the new WPI level times the number of indices in the contract to the buyer— and would be free of controversy, since the government announces it. Those trading can monitor the movement of prices in, say, the commodities market on a daily basis to conjecture how WPI futures would be moving and take a call on whether to buy or sell. The commodity market provides robust prices that can be monitored on a real-time basis.
Who will be the players? A WPI futures market will be of use to financial institutions and individuals, the latter having a direct trading interest in combating inflation. In fact, trading in options instead of futures would be preferable for most individuals: One is freed of the obligation of going through with the contract in case the WPI comes down, for instance. They would just have to approach their brokers or use online trading portals to put in their orders. WPI futures will also provide a comprehensive cover for companies who track specific product prices.
Banks, in particular, would be very keen on this index: They monitor the WPI closely, as it affects their holding of government securities (the price and yield of which can move with inflation). Then there would be the ubiquitous speculators and arbitrageurs who would add liquidity by taking opposing positions: There are always those who gain from higher inflation, just as others might lose.
The fact that the WPI is based on unbiased collection of prices by the government ensures that it cannot be influenced by anyone. So contracts could be weekly or monthly, depending on the index or sub-index. For instance, there could be six-month contracts running for the WPI, which allows participants to take a medium-term view on prices. More importantly, the bouquet can be spread to cover consumer price indices, or CPI, too.
The interesting debate here is on the regulatory turf for such an index, especially since regulators have been at war to decide who should oversee what. Ideally a WPI index should be within the purview of the commodity market regulator, the Forward Markets Commission (FMC). However, in the last six years, the Forward Contracts (Regulation) Act has not been amended to permit index trading, which has prevented exchanges from launching such products. The ball can then be tossed into the securities arena that can deal with such indices—which means the Securities and Exchange Board of India—especially since futures are always exchange-traded.
Because the contracts are non-deliverable, there would be no exchange of physical commodities and hence could be interpreted as being outside the commodity market. This can avoid debate such as the one over electricity futures, where both the electricity regulator and FMC claimed turf; the two regulators are now discussing a way out to integrate the regulatory structure for the physical commodity with futures trading. Also, banks and other financial institutions are outside the purview of commodity markets; their presence is necessary to add depth, which will be possible, under the present circumstances, only on a securities platform.
With inflation becoming a major problem in the way of economic growth, it is essential to have a financial product that offers a hedging option. We can hope that just as retail interest has been engendered in stock markets, a similar trend would develop in WPI futures trading over time.
Inflation remains a major concern today; it’s certainly preoccupying members of India’s Parliament these days. While prices of some commodities can come down at some point of time, the problem is they can get volatile any time. For that, we need a hedge against inflation. There is at present no such hedge available; whether, say, stock indices or interest rates can act as effective hedges has not yet been established. So is there a more direct way to protect against inflation?
The answer is yes. We have the Wholesale Price Index (WPI), which is reported partly every week for some components, while there is a monthly number for the entire index. So we can quite easily have futures on the WPI. A future is a contract to buy something at a preset price, specified today, in the future.
There are two issues here. The first is how these contracts would be structured. The second is the regulatory part which is, admittedly, a tricky subject.
Just as we have Nifty futures traded on the National Stock Exchange—a contract where the seller pays the buyer if the Nifty hits or crosses some level, allowing the buyer to hedge his underlying stock bets—we can have futures trading on the WPI and its components. Unlike the Nifty, which changes every moment and constantly influences bids on the Nifty futures, the WPI will change every week or month. A call on the WPI futures would be based on a subjective conjecture on where the index will be during the settlement date. Hence, in August, someone can take a call on the WPI October futures contract.
We can have a contract size of 500 WPI indices, which will be valued at around Rs125,000 (500 multiplied by the WPI level, currently around 250). Based on the historic volatility of the WPI, the margin would be 5-10% depending on the index (or sub-index) chosen. Hence, an individual with an initial margin of, say, Rs12,500 (10%) can buy one WPI futures contract. For every 1 percentage point increase in the index in the futures market, the trader going long—betting on the index to rise—would be hedged with a gain of Rs1,250 on a single contract.
The contract will be non-deliverable, like Nifty futures, and would hence have no other obligation (unlike the commodity futures market, where there is physical delivery of the underlying commodity). The settlement price would be the actual WPI level for the contract—the seller will pay the new WPI level times the number of indices in the contract to the buyer— and would be free of controversy, since the government announces it. Those trading can monitor the movement of prices in, say, the commodities market on a daily basis to conjecture how WPI futures would be moving and take a call on whether to buy or sell. The commodity market provides robust prices that can be monitored on a real-time basis.
Who will be the players? A WPI futures market will be of use to financial institutions and individuals, the latter having a direct trading interest in combating inflation. In fact, trading in options instead of futures would be preferable for most individuals: One is freed of the obligation of going through with the contract in case the WPI comes down, for instance. They would just have to approach their brokers or use online trading portals to put in their orders. WPI futures will also provide a comprehensive cover for companies who track specific product prices.
Banks, in particular, would be very keen on this index: They monitor the WPI closely, as it affects their holding of government securities (the price and yield of which can move with inflation). Then there would be the ubiquitous speculators and arbitrageurs who would add liquidity by taking opposing positions: There are always those who gain from higher inflation, just as others might lose.
The fact that the WPI is based on unbiased collection of prices by the government ensures that it cannot be influenced by anyone. So contracts could be weekly or monthly, depending on the index or sub-index. For instance, there could be six-month contracts running for the WPI, which allows participants to take a medium-term view on prices. More importantly, the bouquet can be spread to cover consumer price indices, or CPI, too.
The interesting debate here is on the regulatory turf for such an index, especially since regulators have been at war to decide who should oversee what. Ideally a WPI index should be within the purview of the commodity market regulator, the Forward Markets Commission (FMC). However, in the last six years, the Forward Contracts (Regulation) Act has not been amended to permit index trading, which has prevented exchanges from launching such products. The ball can then be tossed into the securities arena that can deal with such indices—which means the Securities and Exchange Board of India—especially since futures are always exchange-traded.
Because the contracts are non-deliverable, there would be no exchange of physical commodities and hence could be interpreted as being outside the commodity market. This can avoid debate such as the one over electricity futures, where both the electricity regulator and FMC claimed turf; the two regulators are now discussing a way out to integrate the regulatory structure for the physical commodity with futures trading. Also, banks and other financial institutions are outside the purview of commodity markets; their presence is necessary to add depth, which will be possible, under the present circumstances, only on a securities platform.
With inflation becoming a major problem in the way of economic growth, it is essential to have a financial product that offers a hedging option. We can hope that just as retail interest has been engendered in stock markets, a similar trend would develop in WPI futures trading over time.
Wednesday, August 4, 2010
Basel III and the new financial order: Business Standard 3rd August 2010
After every crisis, the tendency has been to firm up the regulatory processes so that the inherent malaise is tackled. But such actions have the potential to slow down the economy, which is why they run the risk of being counterproductive. Contrarians argue that better surveillance rather than new laws is more important and could be the real solution as it helps pre-empt a crisis. Changes in the financial order have been discussed and the so-called
Basel III is the latest in the study book. It is an interesting development that adds fresh dimensions to an existing issue, and it will come up for further discussion this November when the G-20 meets. Basel II is still incomplete and we are going to Basel III, which is based more on the wisdom of hindsight. What is this new financial order all about?
The genesis of the large-scale failure was in having highly leveraged institutions that were under-capitalised. The talk, therefore, surrounds these twin issues to ensure a stable banking system in future. Four subjects now dominate the discussion. The first is, of course, capital. The thought process involves making capital requirements more stringent so that there are fewer escape routes and this would, therefore, tackle treatment of off-balance sheet items more closely. Further, capital, or rather Tier- 1 capital, is to be redefined as percentage of risk-weighted assets, and there will be some exclusion such as goodwill, minority interest, deferred tax assets, bank investments in its own shares and provisioning shortfalls. All forms of hybrid capital would be phased out. These definitions are to be put in place by 2012.
The second issue is liquidity. Banks need to have adequate liquidity in order to survive a crisis situation. Here, it has been suggested that liquidity should be adequate to survive a stress period of 30 days. But, the issue of what constitutes liquidity remains unanswered as in the current scenario, sovereign bonds, which conventionally were considered good, have come under a bit of a cloud. The suggested guidelines also talk about the matching of liabilities with assets, as banks typically have short-term liabilities that are associated with long-term assets. More long-term funding is the suggestion here.
The third point of debate pertains to taxes and executive pay. The International Monetary Fund (IMF) has suggested a tax on the assets of the banks to build a corpus that can be used at the time of a crisis. This is contentious since while the UK, the US and Germany have gone along with and are considering a 0.04 per cent tax, France and Canada are opposed to this idea. A consensus will develop on the issue in the course of time.
Compensation has been an eyesore in this crisis and there is official talk of not just deferring bonuses, but also devising systems to claw back the bonuses in case of a crisis. Although this sounds good, it may be hard to implement. Several dealers/bankers had taken risks and got good payoffs when the going was good. However, when the crisis unfolded, on account of the risks that had been taken, they could not be made to pay for their actions. It is still not certain as to how this can be done.
The last issue is about making banks safer institutions. Two thoughts have come up here. The first is to have larger banks, which in the past were considered to be too big to fail, to go in for higher capital charges — a kind of surcharge wherein they have to have higher Tier-1 capital. This is an extension of the concept of pro-cyclical buffers, which are built during good times to take care of the rainy days. Simultaneously, there is a demand to build contingent capital which can be converted from debt to equity in times of crisis. The second pertains to assigning higher weights for proprietary trading activities as the attempt is to restructure banking activities into proprietary trading and main banking activity.
While these proposed guidelines would make banking sound, there are some uncomfortable possibilities that may prop up. To begin with, such firm regulation would put brakes on the expansion of bank credit, which can impede growth. Typically, shocks that affect banks’ capital make them adjust to loan supply to meet leverage and capital ratios. The Institute of International Finance (IIF) has estimated that banks will have to raise up to $700 billion of equity and $5,400 billion of wholesale debt between 2010 and 2015 to meet these requirements. This can affect the recovery process in countries that are dependent on bank finance (Europe) as against the ones dependent on capital markets (the US). IMF VaR (value at risk) models suggest that Europe can lose 2 percentage points growth in GDP on this count. Secondly, there is a case of borrowers shifting to the capital market from banks on account of these constraints, which, in turn, can increase the risk factor. The basic justification of intermediation is the ability to bridge the information asymmetry between borrower and lender. With banks being constrained, there would be a shift to the debt market where the perceived risk could be higher. Third, greater recourse to long-term funding to ensure that banks do not have a liquidity squeeze will have a bearing on cost of operations. Finally, the guidelines on proprietary trading and bonuses will have a bearing on financial innovation. While the exotic products did deal a blow to the financial system in the last few years, admittedly, they did bring about substantial re-engineering and churning of funds to sustain the growth process.
The picture is grim as any new regulation runs the risk of clamping down on a sector that has strayed. While such a discussion is in order, Basel III should try not to drive conservatism so hard that it makes banking difficult. Better surveillance instead of over-regulation, it is felt, may just be what should be recommended today. And surprisingly, there isn’t much talk on this subject.
Basel III is the latest in the study book. It is an interesting development that adds fresh dimensions to an existing issue, and it will come up for further discussion this November when the G-20 meets. Basel II is still incomplete and we are going to Basel III, which is based more on the wisdom of hindsight. What is this new financial order all about?
The genesis of the large-scale failure was in having highly leveraged institutions that were under-capitalised. The talk, therefore, surrounds these twin issues to ensure a stable banking system in future. Four subjects now dominate the discussion. The first is, of course, capital. The thought process involves making capital requirements more stringent so that there are fewer escape routes and this would, therefore, tackle treatment of off-balance sheet items more closely. Further, capital, or rather Tier- 1 capital, is to be redefined as percentage of risk-weighted assets, and there will be some exclusion such as goodwill, minority interest, deferred tax assets, bank investments in its own shares and provisioning shortfalls. All forms of hybrid capital would be phased out. These definitions are to be put in place by 2012.
The second issue is liquidity. Banks need to have adequate liquidity in order to survive a crisis situation. Here, it has been suggested that liquidity should be adequate to survive a stress period of 30 days. But, the issue of what constitutes liquidity remains unanswered as in the current scenario, sovereign bonds, which conventionally were considered good, have come under a bit of a cloud. The suggested guidelines also talk about the matching of liabilities with assets, as banks typically have short-term liabilities that are associated with long-term assets. More long-term funding is the suggestion here.
The third point of debate pertains to taxes and executive pay. The International Monetary Fund (IMF) has suggested a tax on the assets of the banks to build a corpus that can be used at the time of a crisis. This is contentious since while the UK, the US and Germany have gone along with and are considering a 0.04 per cent tax, France and Canada are opposed to this idea. A consensus will develop on the issue in the course of time.
Compensation has been an eyesore in this crisis and there is official talk of not just deferring bonuses, but also devising systems to claw back the bonuses in case of a crisis. Although this sounds good, it may be hard to implement. Several dealers/bankers had taken risks and got good payoffs when the going was good. However, when the crisis unfolded, on account of the risks that had been taken, they could not be made to pay for their actions. It is still not certain as to how this can be done.
The last issue is about making banks safer institutions. Two thoughts have come up here. The first is to have larger banks, which in the past were considered to be too big to fail, to go in for higher capital charges — a kind of surcharge wherein they have to have higher Tier-1 capital. This is an extension of the concept of pro-cyclical buffers, which are built during good times to take care of the rainy days. Simultaneously, there is a demand to build contingent capital which can be converted from debt to equity in times of crisis. The second pertains to assigning higher weights for proprietary trading activities as the attempt is to restructure banking activities into proprietary trading and main banking activity.
While these proposed guidelines would make banking sound, there are some uncomfortable possibilities that may prop up. To begin with, such firm regulation would put brakes on the expansion of bank credit, which can impede growth. Typically, shocks that affect banks’ capital make them adjust to loan supply to meet leverage and capital ratios. The Institute of International Finance (IIF) has estimated that banks will have to raise up to $700 billion of equity and $5,400 billion of wholesale debt between 2010 and 2015 to meet these requirements. This can affect the recovery process in countries that are dependent on bank finance (Europe) as against the ones dependent on capital markets (the US). IMF VaR (value at risk) models suggest that Europe can lose 2 percentage points growth in GDP on this count. Secondly, there is a case of borrowers shifting to the capital market from banks on account of these constraints, which, in turn, can increase the risk factor. The basic justification of intermediation is the ability to bridge the information asymmetry between borrower and lender. With banks being constrained, there would be a shift to the debt market where the perceived risk could be higher. Third, greater recourse to long-term funding to ensure that banks do not have a liquidity squeeze will have a bearing on cost of operations. Finally, the guidelines on proprietary trading and bonuses will have a bearing on financial innovation. While the exotic products did deal a blow to the financial system in the last few years, admittedly, they did bring about substantial re-engineering and churning of funds to sustain the growth process.
The picture is grim as any new regulation runs the risk of clamping down on a sector that has strayed. While such a discussion is in order, Basel III should try not to drive conservatism so hard that it makes banking difficult. Better surveillance instead of over-regulation, it is felt, may just be what should be recommended today. And surprisingly, there isn’t much talk on this subject.
RBI increases its frequency to eight: Financial Express: July 29 2010
A major takeaway from the credit policy is the addition to the number of policy statements that will be made by RBI. This is interesting because it accepts the fact that there has been quite a bit of surprise attached to its own actions in the past, which may not exactly have been market-friendly. Nonetheless, some interesting questions arise. The first is quite fundamental that provokes the question as to whether surprises are good or bad. If you were a follower of Lucas and Sargent, you would say that only monetary surprises work because if all the information in terms of policy targets was made available at a point of time and never changed. Then we, as rational economic agents, would take in this information and plan accordingly, and move towards an efficient solution guided by the ‘invisible hand’. In such a case, discretionary monetary action does not deliver. This is the reason why the proponents of rational expectations maintained that monetary policy would not matter.
Moving from the textbook to reality, we have seen that when the market expects RBI to increase rates by 25 bps, and RBI does so, then nothing changes. This means that if RBI goes by the script and makes changes only in the eight policies then the changes will not matter. Taking the theory forward, Lucas would say that only surprise monetary action works. But, not for too long as the markets discover the same and then revert to their equilibrium.
The second is that if we can expect changes on eight occasions, then will there still be surprises in between. Here, RBI has played safe and said that it would retain the prerogative to intervene in case the situation demands. In such a case, it means that there can still be surprises before September 16. But such an intervention should only be rare or else the purpose of having eight reviews would become superfluous.
The third is that the market is quite touchy and is always on the look out for signals to the extent of finding them where they do not exist. Therefore, whenever RBI officials make a statement in any seminar or outside a seminar, they run the risk of being quoted or quoted out of context, which, in turn, can spook the markets. A RBI official stating that inflation is a major concern can be interpreted as impending action on interest rates. Hence, even if RBI sticks to the eight-policies rule, and does not spring surprises, the market will be monitoring the words of RBI in every forum to pick up signals, which cannot be avoided.
This is significant because today RBI has a problem in so far as that the market is forever guessing what it is going to do, when it will do and what it wants to do. If it does nothing till the policy, then it becomes predictable and may not matter as they buffer in such changes. For monetary policy to be effective, the desired results must accrue. If rates are increased, all interest rates must go up or else the measure falls flat. Hence, if RBI has focused on demand-pull inflation, then when the repo rate is increased, lending rates must also rise. If not, then the purpose will not be achieved and we will end up saying that monetary policy could not control inflation. This leads to another issue of whether the policy change has to be substantially large to actually make a difference. Or alternatively, there has to be a surprise element and the quantum of change must be substantial to be effective.
Today, all central banks meet often—the Federal Reserve had eight meetings while the Bank of England and Bank of Japan meet every month to provide a view on the monetary sector. The ECB meets twice a month, though admittedly only the first is meant to discuss monetary policy. Hence, such fine-tuning is not really out of place in the global context; although changes in interest rates are of a lower frequency in general and there have been times when the central banks have announced monthly changes.
It may be recollected that we used to have two policies earlier—slack and busy seasons, and these concepts were abandoned when it was realised that there were no slack and busy periods, and that we should have four policy reviews. Hence, a further multiple to eight looks in order. However, considering that the market appears to guess right each time what RBI will do, to be effective, there may be a strong case for arguing for more discretionary action to deliver so that the market is impacted.
In a theoretical sense, it will mean abrupt Keynesian fine-tuning within the rational expectations framework.
Moving from the textbook to reality, we have seen that when the market expects RBI to increase rates by 25 bps, and RBI does so, then nothing changes. This means that if RBI goes by the script and makes changes only in the eight policies then the changes will not matter. Taking the theory forward, Lucas would say that only surprise monetary action works. But, not for too long as the markets discover the same and then revert to their equilibrium.
The second is that if we can expect changes on eight occasions, then will there still be surprises in between. Here, RBI has played safe and said that it would retain the prerogative to intervene in case the situation demands. In such a case, it means that there can still be surprises before September 16. But such an intervention should only be rare or else the purpose of having eight reviews would become superfluous.
The third is that the market is quite touchy and is always on the look out for signals to the extent of finding them where they do not exist. Therefore, whenever RBI officials make a statement in any seminar or outside a seminar, they run the risk of being quoted or quoted out of context, which, in turn, can spook the markets. A RBI official stating that inflation is a major concern can be interpreted as impending action on interest rates. Hence, even if RBI sticks to the eight-policies rule, and does not spring surprises, the market will be monitoring the words of RBI in every forum to pick up signals, which cannot be avoided.
This is significant because today RBI has a problem in so far as that the market is forever guessing what it is going to do, when it will do and what it wants to do. If it does nothing till the policy, then it becomes predictable and may not matter as they buffer in such changes. For monetary policy to be effective, the desired results must accrue. If rates are increased, all interest rates must go up or else the measure falls flat. Hence, if RBI has focused on demand-pull inflation, then when the repo rate is increased, lending rates must also rise. If not, then the purpose will not be achieved and we will end up saying that monetary policy could not control inflation. This leads to another issue of whether the policy change has to be substantially large to actually make a difference. Or alternatively, there has to be a surprise element and the quantum of change must be substantial to be effective.
Today, all central banks meet often—the Federal Reserve had eight meetings while the Bank of England and Bank of Japan meet every month to provide a view on the monetary sector. The ECB meets twice a month, though admittedly only the first is meant to discuss monetary policy. Hence, such fine-tuning is not really out of place in the global context; although changes in interest rates are of a lower frequency in general and there have been times when the central banks have announced monthly changes.
It may be recollected that we used to have two policies earlier—slack and busy seasons, and these concepts were abandoned when it was realised that there were no slack and busy periods, and that we should have four policy reviews. Hence, a further multiple to eight looks in order. However, considering that the market appears to guess right each time what RBI will do, to be effective, there may be a strong case for arguing for more discretionary action to deliver so that the market is impacted.
In a theoretical sense, it will mean abrupt Keynesian fine-tuning within the rational expectations framework.
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