RBI Signals Resumption Of Normal Liquidity Management Operations
A decision to restart variable rate reverse repo auctions will help push up short term interest rates.
The Reserve Bank of India said it will resume normal liquidity management operations as the economy and financial market conditions stabilise. The first steps announced by the central bank will help target the price of liquidity by pushing up short-term rates even as the banking system remains flush with funds.
“On a review of evolving liquidity and financial conditions, it has been decided to restore normal liquidity management operations in a phased manner,” the central bank said in a release on Friday.
Alongside, it announced the resumption of variable rate reverse repo auctions. The first such auction for a maximum amount of Rs 2 lakh crore and a tenor or 14 days will be held on Jan. 15, 2021.
The auction will permit banks to park surplus funds with the RBI while earning near the reverse repo rate of 3.35% and reduce the incentive to lend at lower rates. As such, very low short-term rates on treasury bills and commercial paper may move up marginally. To be sure, mutual funds and insurance companies, that do not have access to the reverse repo window, may continue to park surplus liquidity at rates below the reverse repo rate.
In a note in December, Kaushik Das, chief India economist at Deutsche Bank, had said “there is scope for the RBI to announce some measures to rectify the price of liquidity before the February 2021 monetary policy meeting.” The next steps could be aimed at the extent of surplus liquidity. While India’s Monetary Policy Committee will likely maintain an accommodative stance at its February policy, it “may provide some signal regarding the need for right-sizing the quantum of excess liquidity and aligning short-term interest rates to the reverse repo rate of 3.35%, if the divergence continues until then”, Das had said in a Jan 5. note.
Easy Liquidity; Low Rates
After the virus outbreak, the RBI has allowed large surplus liquidity to persist. This has continued with surplus liquidity remaining between Rs 6-7 lakh crore in recent days.
The flood of money in the system has driven down short-term rates to even below the RBI’s reverse repo rate of 3.35%, at which banks can park money with the central bank. As a result, the government and a number of corporate borrowers have been able to borrow at below the benchmark policy rate of 4%.
At the latest auction, 91-treasury bills were sold at a coupon rate of 3.03%. As BloombergQuint earlier reported, a number of corporate borrowers have raised short-term commercial paper at close to 3% as well.
The RBI’s announcement will have a signaling effect, said Soumyajit Niyogi, associate director at India Ratings & Research. This will eventually help realign the short-term rates towards the repo rate, said Niyogi, explaining that so far the RBI has allowed money market rates to remain below the repo rate.
“We can expect the yield on 1-3 month securities rise by up to 15-18 basis points, while securities with tenor up to one year could see yields moving higher by up to 10 basis points. The action is largely neutral for longer tenor paper and thus the impact on the 10-year yield, purely because of this statement, is not going to be much,” said Madhavi Arora, economist at Emkay Global.
