Bank rate lacks clarity: HSBC

The inflation rate has climbed by about 300 basis point in the last one year and the bank rate has actually come down which sends a very confusing signal. But viewed in the perspective of the need to boost the economic growth, the decline assumes a new meaning. “Which is where an articulation of the central bank objective and its assessment of the economy becomes important,” the paper said. India still has a long way before the role of the bank ratebecomes clear. In US, the Fed merely targets the Fed funds rate, which is essentially a short-term rate. There is no target that the Fed has on the long bond yield or any other yields.

In India, the general impression is that the bank rate is a barometer of the long-term rate. Alternatively, it is also construed as having a slightly longer term but general impact. In India the yield scenario is determined mostly by the behaviour of the overnight rate and the sovereign yield curve because the volatility and funding risk associated with the overnight rate.

The linkage with the export re-finance and the primary dealer refinance is the only link that the bank rate has with the overnight rates as it purportedly provides a cap. Other than that, the link is somewhat tenuous. As long as the bank rate is not all permeating in its scope, its efficacy will always be uncertain. Its efficiency can then stem from `shock ‘ value – by surprise announcements of changes.

“The role of the bank should be strengthened.The overnight cash is the locomotive of the market. The bank rate influences this through the link with refinance. What blunts this link is that the spread over the bank rate, for this refinance is not an inviolable factor,” it said.

Pointing out the loopholes in the system, the paper said that the export refinance is sometimes at bank rate, sometimes at bank rate less 200 basis points (presently). The variation in the factor renders the link virtually meaningless because the factor itself becomes a tool. When the bank rate was revitalised two years ago, a credible link was the maximum deposit rate that banks could pay for deposits for less than one year.

This impacted on the cost of funds and hence had a very direct link to lending rates and the to the overall interest rate structure in the economy. As a positive step towards interest-rate deregulation, this restriction was relaxed but that diluted the importance of the bank rate, it said.

There could also a link with three month or the one yearT-bill rate. The one year rate for some time was the lowest rate in the system reflecting the liquidity and credit worthiness of the instrument. At that time, the bank rate was 100 basis points above this yield. Presently, the bank rate is 60 basis points below this yield and has been on par for quite some time.

There are other things that can be tried in order to elevate the status of `bank rate’ as a signalling device. But the process is a long one and requires meticulous consistency and experience over the years will make it easier for RBI to deliver and the markets to accept a `static free’ transmission. There can be no compromises, a `good’ tool cannot be made to demand respect indefinitely, rather it should command natural acceptance, it said.