Bloomberg News

Open-Market Operations May Hurt Price Stability, Subbarao Says

February 01, 2012

Feb. 1 (Bloomberg) -- Open-market operations such as buying and selling of government securities by central banks to manage liquidity in the financial system may hurt price stability, Reserve Bank of India Governor Duvvuri Subbarao said.

While policy makers conduct such actions to ensure there is sufficient cash in the banking system, price stability could be held “hostage” if the operations are used to help a “fiscally vulnerable sovereign” or to reduce the cost of borrowing for the government, Subbarao said in a speech in Mumbai today.

“In India, the question has been whether the OMOs conducted by the Reserve Bank to manage systemic liquidity are acting as a disincentive for fiscal discipline,” Subbarao said.

The Reserve Bank has boosted borrowing costs 13 times since March 2010 to stem price pressures in the Indian economy before leaving the benchmark repurchase rate unchanged at 8.5 percent for the second month in January.

The central bank on Jan. 24 lowered the amount of deposits lenders need to set aside as reserves for the first time since 2009, saying it was to “address structural pressures on liquidity in a way” consistent with the prevailing monetary stance. The RBI has bought 719 billion rupees ($14.6 billion) of bonds since November to ease a cash squeeze at banks.

Another question confronting central banks is whether they are “being forced beyond their comfort zone to subordinate their monetary policy stance to the government’s fiscal stance,” Subbarao said today.

India’s budget deficit reached 92.3 percent of the fiscal- year target in the nine months through December, government data showed yesterday, compared to a 44.9 percent shortfall in the same period a year earlier. The federal government in December increased its annual borrowing program by 8.5 percent to 5.1 trillion rupees.

Finance Minister Pranab Mukherjee has said cutting the deficit is a “serious challenge.” The nation’s fiscal deficit may reach 5.6 percent “with an upside risk” in the financial year to March 31, Standard Chartered Plc forecasts, compared with the government’s 4.6 percent target.

--With assistance from Tushar Dhara in New Delhi. Editors: Rina Chandran, Shamim Adam

To contact the reporters on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net Anoop Agrawal in Mumbai at aagrawal8@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net


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