Ajay Shah in his last post raises the issue of the RBI’s approach to affecting interest rates, and the inexplicable gap between the two policy rates it quotes. Here are some thoughts and some data.
First, some definitions:
The repo rate is the rate at which the RBI lends to banks for the short term, and the reverse repo rate is what it pays on short-term deposits by banks with the RBI. The “repo” here is an abbreviation of “repurchase,” and has nothing to do with the “repo man” who repossesses cars in the US!
These terms can be compared to those used in the US (from FRB web pages):
“The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank’s lending facility – the discount window.”
“The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.”
In the US, the fed funds rate is what matters – discount window borrowing is rarely used. I understand what the Fed does, influencing the fed funds rate through open market operations. I am still trying to figure out
- what the RBI does,
- why the repo rate and reverse repo rate are both used, and
- why the gap between them varies over time.
Here is some data on the history of the two RBI policy rates. I still have to complete the figures on the reverse repo rate, but you can see how the gap varies. One conjecture to explain this variation is that the RBI has varying compulsions with respect to the costs it bears of conducting its “liquidity adjustment” operations. I was also struck in this data by how high the repo rate was in 2000. This time, the preferred method of combating inflation seems to have been increases in the cash reserve ratio. I guess that’s cheaper for the RBI, and it also may be determined by the needs of exchange rate “management.”
Honestly, I have been reading through RBI documents quite a bit, and can’t seem to get very clear or simple answers. I realize I’m not a monetary economics specialist, but the US Fed tries to make things simple for even the non-economist.