Developing the Money Market

Now that the RBI has come out with a ‘mini-credit policy’, there is an all-pervasive sense of anti-climax. What can the actual policy announcement due later this month possibly contain, seems to be the general refrain. But that is being short-sighted. Fine-tuning monetary policy is an ongoing process that does not, and indeed should not, be linked to the bi-annual monetary policy announcement of the RBI. The latter should rather be regarded as a launch pad for institution-building and laying out the framework for financial sector reform. In the Indian context, this is of crucial importance as one of the major handicaps faced by the RBI in influencing monetary policy is the inefficacy of its monetary signals which is, in turn, primarily because of the absence of a good and efficient money market.

In the past this was of little consequence. The RBI dictated and banks did as bid. Interest rates were adjusted by the RBI in accordance with its policy imperatives and its desire to influence the flow of ‘scarce’ credit to desired sectors, including the government. However, liberalisation and financial sector reforms have put an end to this cosy arrangement. Like central banks the world over, the RBI is now compelled to use market instruments to intervene in the market. And since it is the money market that provides a focal point for central bank intervention – for influencing liquidity and the general level of interest rates in the economy – the success of its intervention depends critically on whether the money market is developed enough to respond to the signals received from the central bank.