MPC Meet: Why Citi Thinks The RBI May Hike The Reverse Repo Rate

The Reserve Bank of India could consider hiking the reverse repo rate by 15 basis points as the economy's need for emergency monetary policy relief reduces, said Samiran Chakraborty, chief economist- India at Citibank.

India's Monetary Policy Committee is scheduled to meet this week, with a decision due Friday. The RBI, which still controls key aspects of monetary policy, including the reverse repo rate and the liquidity operations, typically reviews its policy alongside.

The reverse repo rate, which forms the floor of the policy rate corridor, was cut by 155 basis points to 3.35% due to the Covid crisis, while the repo rate was reduced by 115 basis points to 4%.

Chakraborty said while any adjustment in the repo rate is some time away, it may be time for a reverse repo rate hike. There is a fundamental reason and a technical reason for a reverse repo rate hike, he said.

"The fundamental reason is that during the pandemic, there were two emergency measures—one is that the operative rate was moved to reverse repo and the second is that the repo-reverse repo corridor was widened," Chakraborty explained in an interview with BloombergQuint.

With the expectation that a third wave of Covid-19 infections, if any, may inflict less damage on the economy, emergency economic conditions may have passed, reducing the need for a wider interest rate corridor or an ultra-low reverse repo rate. "These two measures now need to be slowly retracted."

The technical reason, Chakraborty said, is a wider interest rate corridor leads to excessive fluctuation in short term rates. "This isn't desirable from a monetary policy perspective."

The market has almost priced in a 15 basis points hike in the reverse repo auction, according to Chakraborty. This after the central bank set a cut-off of 3.99% at the last variable rate reverse repo auction, signaling comfort with higher short-term rates.

However, any move to raise the reverse repo rate will have to be accompanied with very clear communication, to ensure that long-term bond yields don't rise much further. "This distinction between emergency measures and cyclical/structural measures, that distinction is important."

The central bank is also grappling with the question of how to tackle a very large surplus of liquidity, currently ranging between Rs 10-12 lakh crore. According to Chakraborty, the central bank may not be too worried about this level of liquidity yet if it can manage the cost of liquidity.

Citi expects that the RBI will start winding down G-SAP bond purchases. If these continue, they will come alongside short term bond sales to avoid adding further liquidity operations.

"The key point is that RBI has demonstrated that even with shorter term VRRR (variable reverse repo rate) auctions, it's possible to push short-term rates all the way to the repo rate," Chakraborty said. "You don't actually need to cut out liquidity in the system through a cash reserve ratio hike or a maket stablisation scheme bond."

Watch the full conversation below: