RBI’s Long-Term Repo Operations Seen As Stealth Move To Bring Down Rates

The Reserve Bank of India has decided to introduce long-term repo operations into its liquidity toolkit— a measure that market participants expect will bring down short term rates sharply and also prompt increased investment in corporate bonds.

These LTROs, together with the RBI’s earlier introduced ‘Operation Twist’, are an attempt by the central bank to manage bond yields and push transmission of already announced interest rate cuts.

In its statement on developmental and regulatory policies, the RBI said it has decided to conduct LTROs starting the fortnight beginning Feb.15, 2020.

“The RBI shall conduct term repos of one-year and three-year tenors of appropriate sizes for up to a total amount of Rs 1 lakh crore at the policy repo rate,” the RBI said. As such these operations will be conducted at the prevailing repo rate of 5.15 percent.

WATCH | Bel Neeraj Gambhir, head of markets at Axis Bank explains the impact of RBI’s Long Term Repo Operations.

How It Will Work

Short-term bond yields fell sharply after the announcement of the LTRO.

Ananth Narayan, associate professor of finance at SP Jain Institute of Management and Research, said the effect of LTRO will be akin to “an elephant sitting on bond yields”. He added that the impact of such operations will be “bigger than a rate cut” in terms of bringing down yields.

The impact will play out via an adjustment of the arbitrage that may exist between the market yields on short-term securities and the yield at which RBI will offer funds for 1-year and 3-year duration. Since the central bank will offer funds at repo rate of 5.15 percent, the yield on risk-free government securities of the corresponding tenors will fall closer to the benchmark rate.

“This will help push down the near end (1-4 year) government securities yield curve and eventually also impact long-term bond yields,” Narayan explained.

Arvind Chari, head of fixed income at Quantum Advisors, said the RBI’s facility is a stealth move to bring down rates.

“The RBI has emulated the ECB action by introducing “long-term repo”. The RBI has announced 1-year and 3-year LTRO at the policy repo rate, which is a big move to durably address the monetary transmission phenomenon. This new liquidity infusion will be over and above the existing excessive liquidity situation of Rs 2-3 lakh crore,” Chari said. He, however, added that the introduction of LTRO may mean that the RBI will not conduct further open market purchases under its ‘Operation Twist’ programme.

B Prasanna, head of global markets at ICICI Bank termed Thursday’s policy review as RBI’s ‘Whatever It Takes’ moment and said that the decision to introduce long term repo operations was the “crowing glory” of the policy.

“LTRO at the repo rate that is intended towards facilitating better transmission in the bond and loan markets. Besides lowering rates in the short end of the sovereign curve it is also likely to lower Corporate Bond yields, deposit rates and lending rates,” Prasanna said.

Market Reaction

Bond markets reacted sharply to the introduction of the new facility.

Yields on 3-year and 5-year government bond fell sharply by between 10-15 basis points after the announcement. The decline on the benchmark 10-year bond was more modest at about 4 basis points.

Broader Liquidity Toolkit

The long term repo operations are part of a revamped liquidity management toolkit under the RBI’s new framework. The framework has maintained the weighted average call rate as the operative rate for monetary policy. The corridor of interest rates -- which ranges from the reverse repo rate at the lower end to the marginal standing facility rate at the upper end -- has also been retained.

The extent of liquidity surplus or deficit has not been limited by any quantitative targets under the new framework. However, the RBI has made adjustments to the tools it can use.

According to the RBI release, short term liquidity mismatches would be met using:

• 14-day variable rate repo or reverse repo operations
• Variable rate term repo or reverse repo
• Marginal standing facility
• Forex swaps
• Standing deposit facility, when it is activated

Longer term durable liquidity mismatches will be met using:

• Long term variable rate repo or reverse repo
• FX swap operations
• Open market operations.