This time, the Reserve Bank of India's Review of Monetary Policy will have an extra frisson of excitement -- it will be Y V Reddy's first major policy statement.

Reddy is widely perceived to be more market-friendly than his predecessor. The yo-yoing of the rupee in recent weeks has led market participants to believe that the RBI is adopting a less intrusive, more hands-off approach, allowing more play for market forces.

The central bank's aggressive sucking out of liquidity has been viewed as deft management of market expectations on the eve of the policy review, again reflecting a more respectful approach to the market. But all that may be wishful thinking, and bankers may be reading too much into the change of guard. We'll know on Monday.

The repo rate and the bank rate: What are the market's concerns? The near certainty of a repo rate cut has, after the carnage in the last couple of weeks, been replaced by an equally strong belief that the repo rate will remain unchanged.

There have been enough indications from the central bank about that, both from open market and repo operations draining liquidity and from not-so-delphic utterances about "irrational exuberance".

With inflation edging up in the past few weeks, there's no particular reason to reduce repo rates further, especially since there's little doubt that longer-term bond yields will follow the repo rate downward, and the shape of the yield curve will not therefore change.

On the other hand, yields have jack-knifed up in the past few days and there's a severe shortage of cash, so perhaps the central bank needs to signal that it has no intention of abandoning its soft stance.

That signal may be made through the bank rate, which may be taken down a notch or two. The market is certainly expecting a bank rate cut, although, given the lack of linkage between the bank rate and other rates, it's unclear what precise effect it is expected to have.

Most central banks all over the world signal their interest rate stance through repo rates and the traditional explanation for our keeping the bank rate is that it is supposed to indicate a change in long-term rates.

Well, the last few repo rate changes have led to steep falls in long-term rates in the market as well. Perhaps it's necessary for the RBI to say what exactly it means when it wants a change in the bank rate -- is it just the prime lending rates?

And why should the PLR be linked to the bank rate, and not to other market rates? The RBI's signalling mechanism will also change dramatically should there be differential repo rates, as is being suggested by some.

Nevertheless, the RBI has given several signals in the past that it's concerned about the benefit of lower interest rates not being passed on to second-rung borrowers. Several solutions have been mooted, all of them involving some tinkering with the PLR, and all of them unsuccessful.

Rupee appreciation and exports: One clear example that mandated interest rates do not work is provided by dollar loans to exporters, which are capped at Libor plus 75 basis points. Exporters have been complaining bitterly that banks are not giving them dollar loans.

But with a severe shortage of dollars in the market -- forex dealers complain that the RBI sucks up all the dollars, leaving nothing for them -- banks say that they are in no position to fund dollar loans.

Even if dollars are available in the market, their cost will be in the region of Libor plus 300 basis points, and no exporter will get money at Libor plus 75 basis points. This rate needs to be freed.

Banks also want the RBI to relax the ceiling on Foreign Currency Non-Resident deposits -- Libor minus 25 basis points -- so that more dollars can flow in. But with the rupee under constant upward pressure due to dollar inflows, it's doubtful whether the central bank will be happy seeing more dollars coming in.

Faced with the dollar shortage, banks resorted to buy-sell swaps -- buying spot dollars and selling them forward -- and that forced down dollar forward premiums.

The RBI's apparent unconcern with that development has been interpreted by some dealers as a smart move, aimed at catching all those who were short of dollars on the wrong foot. But plunging forward premiums have also hit exporters, who are in any case having a difficult time thanks to the appreciating rupee.

That brings one to the other concern, which is the rupee appreciation and its effect on exports. One solution that has been mooted is for the RBI to go further on the road to capital account convertibility.

That could well happen, but such measures haven't had any effect on the rupee earlier. Who will want to go long on a dollar weakening against all major currencies?

There's also another problem -- the central bank has been shouting from the rooftops that this whole business of importers not covering their risks is fraught with danger.

Market players point out that the rupee has become more volatile, possibly an indication that the RBI wants to scare importers into covering. If so, there are few signs of that happening yet. The policy review may contain clues about how the RBI plans to deal with the problem.

Arbitrage flows, which the RBI has attempted to reduce through lower caps on non-resident external deposits, are now being parked in savings bank accounts, which offer higher rates. The central bank may, therefore, lower savings bank rates further, rather than free them.

CRR and structural reforms: What about a credit reserve ratio cut? Those who expect one say that moving to a lower CRR is a policy measure, and the central bank may go ahead with it irrespective of the level of liquidity. Others point out that a CRR cut will be directly contradictory to the RBI's policy of sucking out liquidity from the system.

Actually, a cut could easily be accommodated with reduced liquidity -- all that the RBI has to do is increase the amount of repos or open market operations. But the problem, from the RBI's point of view, is the dearth of marketable securities available for open market operations.

Structural reforms are expected to continue. The wish-list includes several innovations promised earlier, such as STRIPS, which splits up the capital and interest portions of securities for sale to different types of investors, and credit derivatives, which allow banks to spin off the credit risk. More generally, banks are looking for ways to make derivatives work.

Talks are already on to discard the unworkable synthetic zero coupon yield curve in favour of market-based solutions. The requirement that interest rate derivatives can be used only to hedge should be discarded.

If an investor doesn't like a security, all he has to do is sell -- why does he need to hedge it? Banks also want to be present in the equity derivative markets. Other proposals include allowing the rollover of repos, the move to the third stage of DVP (delivery versus payment), which would allow settlement of securities on a net basis, in addition to the net settlement of cash at present.

Banks want the Investment Fluctuation Reserve to qualify as Tier 1 capital and the replacement of the flat 5 per cent IFR by a reserve based on a bank's portfolio -- for example, a bank with a long duration portfolio should have a higher IFR than one invested entirely in T-bills.

There could be a road map to the real time gross settlement system, fine tuning in the call money market and the liquidity adjustment facility and there's a demand by primary dealers to access external commercial borrowings and allowing them to buy international debt, like mutual funds.

So what will be Reddy's approach? In April last year, speaking on monetary and financial reforms, this is what he had to say, "..it is necessary to have an appropriate mix of surprise elements and anticipated elements in policy actions for meeting any uncertainties.

As an example, when the markets are in need of comfort or assurances, when the convergence in the objectives of policy makers and the markets are matched...there is merit in taking the market into confidence.

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