All eyes on RBI's take on liquidity

The apex bank's take on other issues such as liquidity & transmission are gaining paramount importance in the economy

The Reserve Bank of India’s (RBI) monetary policy review on Tuesday is awaited by economists, as apart from rate action, the central bank’s take on other issues such as liquidity and transmission are gaining importance.

It is widely expected that RBI will bring down its policy rate by 25 basis points (bps) in its first bi-monthly policy review for 2016-17, on April 5. With a marginal cost-based lending rate starting Friday, the latter will have to improve the transmission, too, but in the absence of adequate system liquidity, this will be severely hampered.

“We would be looking out for the policy language, in general. It will be of specific interest if RBI offers any guidance as regards their stance on supporting system liquidity in the coming months,” said Siddhartha Sanyal, chief India economist, Barclays, adding, “Since the scope for further rate cuts is relatively limited, comfort on liquidity will become important and aid in transmission.”.

Through various liquidity support windows, banks borrowed Rs 2.1 lakh crore from RBI on Tuesday. The government’s surplus cash balance with the central bank was Rs 1.51 lakh crore, indicating it is holding on to its cash before the financial year comes to an end. However, from the start of the financial year, most of the cash hoarded by the government will come back into the system. Still, economists say the liquidity deficit is assuming a structural nature and the Reserve Bank needs to communicate its strategy to tackle this in the policy.

“There should be some communication on liquidity support, particularly how they are going to handle the situation when foreign currency non-resident (FCNR) deposits mature from September,” said Indranil Pan, chief economist, IDFC Bank.

About $20 billion of FCNR deposits will mature between September and November and the banking system is expected to be in a deep liquidity crisis, as the deposit wipeout will be difficult to compensate for. Probably anticipating the potential drain, RBI officials, in the earlier policy, had said the central bank was working on revising its liquidity framework.

“We can expect some details of the new framework, or at least a clear timeline on the new framework. Despite liquidity support by RBI through bond purchase, etc, we have not seen much of a respite,” said Upasna Bharadwaj, economist at Kotak Mahindra Bank.

Improved liquidity will also aid effective policy transmission. But, economists expect some communication from RBI on the need for banks to pass on rate cuts.

“As the overall consensus is that we are close to a terminal rate, with very limited hope for incremental cut later, it is important for RBI to ensure effective transmission by way of communication in sync with a policy stance and strategy,” said Soumyajit Niyogi, associate director (credit & market research group) at India Ratings & Research. However, the central concern for economists will always be inflation and some economists expect prices to rise at a much slower rate in the next financial year.

“The important factor to look for in the policy will be the ‘fan chart’ on inflation. We would want to check the lowest point on inflation projected by RBI to gauge how different we are now,” said Soumya Kanti Ghosh, chief economist at State Bank of India, adding inflation could fall even below four per cent in the next financial year.