RBI seen targeting liquidity this time

New Delhi: The monetary policy committee (MPC) of the Reserve Bank of India (RBI) is likely to leave interest rates unchanged in its bi-monthly policy review this week but could announce measures to suck excess liquidity out of the system. The six-member MPC will meet for three days starting October 6. Economists also expect the MPC to revise its inflation projections downwards.

Madhavi Arora, lead economist, Emkay Global Financial Services, said, “We are not expecting any change in the repo rate or the reverse repo rate though there could be a bit of a hesitancy from the RBI in infusing liquidity via the GSAP route, and higher variable reverse repo rate (VRRRs) in terms of quantum and tenor. There would be a need to further signal the need to normalise liquidity via higher tenor and quantum of VRR. There is still a slack in the economy and the RBI may not want to shock the system, so they would go step by step and therefore prefer a VRR route and then once the market is prepared, they would go for a rate hike, maybe in December to February policy.”

D. K. Joshi, chief economist at Crisil, said, “The MPC may announce liquidity reducing measures, a hike in reverse repo rate is also a possibility as the banks would then like to park money with the RBI at a higher rate. The RBI will have to indicate some kind of liquidity normalisation and that is what they will do.”
The RBI had last cut the repo rate by 40 basis points on May 22, 2020 to 4 per cent to boost demand and refrained from taking any action on interest rates.

Additionally, it has kept liquidity in surplus to keep lending rates low for borrowers and boost economic growth in a Covid-hit economy. This had resulted in the reverse repo becoming the operative repo rate. There were some indications of policy normalisation in the August meeting of the rate panel when the central bank increased the size of the VRRR auction, which is of a longer duration than the overnight reverse repo, to Rs 4 lakh crore against Rs 2 lakh crore before, though RBI governor Shaktikanta Das had denied it was a case of liquidity tightening.

The RBI in a surprise move last week had set a higher cut-off yield for the 7-day variable reverse repo auction at 3.99 per cent, which is closer to the repo rate of 4 per cent, and not that of the reverse repo which is 3.35 per cent.  Some economists have read this as the central bank’s willingness to normalise the liquidity management operations earlier than expected.

Economists also expect the MPC to revise inflation projections downwards as it has receded below RBI's upper target range of 6 per cent and also printed below market expectations. The CPI inflation for August declined further to 5.3 per cent compared to 5.6 per cent in July 2021. Inflation print has now declined 100 bps in two months from 6.3 per cent in June 2021.