The Reserve Bank of India (RBI) logo is displayed on a gate at the central bank’s headquarters in Mumbai. (Photographer: Vivek Prakash/Bloomberg)

RBI Needs To Step Up Pace Of Liquidity Infusion, Say Analysts

With banks borrowing more from the Reserve Bank of India than they have in at least the last two years, market participants feel that the central bank needs to intervene more decisively to calm nerves.

The liquidity deficit has moved closer to Rs 1.5 lakh crore in recent weeks driven by reasons ranging from advance tax outflows and increased demand during the festive season, to intervention in the currency markets. Other factors such as the approaching election season, when demand for currency increases, could mean that liquidity tightness will persist.

As such, most economists and money market analysts see the need for more frequent bond purchases under the RBI’s open market operation program. On Monday, the RBI announced bond purchases worth Rs 10,000 crore - the second such purchase of the month.

Open Market Operations (OMO) by the central bank can help contain the domino effects of liquidity tightening in the financial markets, said Bank of America Merrill Lynch in a report on Tuesday. The RBI will need to inject $40 billion (about Rs 2.8 lakh crore) by March 2019, the report estimates while adding that a calendar of bond purchases under the OMO scheme would give markets more clarity on the outlook for liquidity.

Bond purchases by the RBI will help bring down yields and reduce foreign portfolios from the debt markets, which in turn could support the rupee, the report added. Foreign investors have sold over Rs 46,000 in the debt markets so far this year.

RBI Needs To Step Up Pace Of Liquidity Infusion, Say Analysts

Kotak Mahindra Bank, in a report, estimated that the RBI would need to purchase bonds to the tune of Rs 1.5-2 lakh crore by March 2019. Economists at the bank believe that liquidity will remain tight in the second half due to increased currency demand during the festive season, intervention in the forex markets and cash build-up by the government.

But even with continued bond purchases, Kotak Mahindra Bank expects short term lending rates would continue to remain elevated. “It is unlikely to completely offset the liquidity tightness implying that the short-term rates would still likely remain elevated,” the report said.

RBI Needs To Step Up Pace Of Liquidity Infusion, Say Analysts

Commenting on the troubles specifically in the NBFC sector, the Kotak economists said they do not expect that to precipitate into a full fledged liquidity crisis. The recent squeeze in money market liquidity has mostly been on the back of portfolio adjustments in debt funds, which had a relatively larger exposure to specific entities, said the report.

Should the RBI feel the need to address the specific liquidity needs of either mutual funds holding debt paper or non-bank lenders, it would need to craft out a special facility. One option could be to open a special liquidity window for mutual funds. It has done so at least twice in the past decade in 2008 and 2013. The facilities, while barely used, send a comforting message to the market and market participants, said an analyst who spoke on condition of anonymity.

Channeling liquidity into NBFCs may prove to be more challenging if banks remain averse to lending to that segment. In such a situation, a line of refinance could be considered, this analyst added.