The Central Bank possesses a wide range of tools to be used as instruments of monetary policy. The main monetary policy instruments currently used are (a) policy interest rates and open market operations (OMO), and (b) the statutory reserve requirement (SRR) on commercial bank deposit liabilities.

(a) Policy Interest Rates and Open Market Operations (OMO)

At present, the Central Bank conducts its monetary policy under a system of active Open Market Operations. The key elements of the system are (i) an interest rate corridor formed by the main policy rates of the Bank i.e. the repurchase rate and the reverse repurchase rate, (ii) a daily auction either to absorb or inject liquidity, (iii) a standing facility at interest rates at the bounds of the corridor and (iv) outright transactions.

The main instruments to achieve the path of the reserve money targets are the repurchase rate and the reverse repurchase rate of the Central Bank which form the lower and upper bounds for the comparable overnight interest rates in money markets. These rates, which are the Bank\'s signalling mechanism on its monetary policy stance, are reviewed on a regular basis, usually once a month, and revised if necessary.

A daily auction is conducted either to absorb liquidity through repurchase transactions, if there is excess liquidity, or to inject liquidity through reverse repurchase transactions, if there is a shortage of liquidity and thereby to maintain overnight interest rates stable around a level considered consistent with the path of reserve money targets. The auction is on a multiple bid, multiple price system. Participants could make up to three bids at each auction and the successful bidders would receive their requests at the rates quoted in the relevant bid.

Standing facilities are available for those participating institutions which were unable to obtain their liquidity requirements at the daily auction. That is, even after the daily auction, if a participant has excess money he could enter into a repurchase transaction under the standing facility. Similarly, if a participant needs liquidity to cover a shortage, he could borrow funds on reverse repurchase basis under the standing facility. Accordingly, these facilities help containing wide fluctuations in interest rates.

Outright transactions are conducted at the discretion of the Central Bank to address long term liquidity issues. If a relatively large liquidity surplus exists and is likely to persist for a long period it is absorbed by selling Treasury bills outright out of the holdings of the Central Bank, and if a sufficient stock of Treasury bills is not available, by issuing the Central Bank\'s own securities. Similarly, a long term liquidity shortage would be removed by purchasing Treasury bills and bonds in the secondary market and buying Treasury bills in the primary mark

There also exists another policy rate known as the Bank Rate. It is the rate at which the Central Bank provides credit to commercial banks as a lender of last resort. These are collateralised loans and government securities are accepted as collaterals. The Bank rate is usually a penalty rate and it is higher than other market rates. Therefore, at present this rate is just an indicative rate as commercial banks can borrow from the Central Bank at the reverse repurchase rate which is less than the Bank rate.

(b) Statutory Reserve Requirement (SRR)

The statutory reserve ratio (SRR), i.e., the proportion of the deposit liabilities that commercial banks are required to keep as a cash deposit with the Central Bank, also has been widely used to influence money supply in the past. However, the reliance on SRR as a day to day monetary management measure has been gradually reduced with a view to enhancing market orientation of monetary policy and also reducing the implicit cost of funds which the SRR would entail on commercial banks.

Under the MLA, commercial banks are required to maintain reserves with the Central Bank at rates determined by the Bank. At present, demand, time and savings deposits of commercial banks denominated in rupee terms are subject to the SRR and the applicable ratio is 10 per cent on all deposit liabilities.