BS Policy poll: Pause for sure, liquidity to be back in focus at RBI

The apex bank would still like to drain out some liquidity while managing yields through OMO or operation twist, to fend off inflation, especially when rate hikes seem distant

Economists and bond market participants do not expect rate cuts anytime soon, but the Rs 12 trillion borrowing numbers outlined by the centre for the next year, and the extra Rs 80,000 crore borrowing for the remainder of this fiscal again brings back focus on liquidity operations by the Reserve Bank of India (RBI).  

The RBI has just started normalising its liquidity operations, but the huge borrowing may apply a break on that process. Nevertheless, the central bank would still like to drain out some of the liquidity, while managing yields through open market operations (OMO), or operation twist (OT), to fend off inflation especially when chances of rate hikes seem distant.   

The bond yields continued to rise on Tuesday. The 10-year bond yield closed at 6.15 per cent, from 5.95 per cent before the budget.  

 

“The challenge now could emanate from rising spread between rising market-based rates and low policy rate, when the incremental credit in the banking system has now been linked to repo. Normalisation of monetary policy which started with announcement of term reverse repo auction will continue in a gradual manner. But post the Union budget the market would be interested to know RBI’s comfort level of surplus liquidity in the foreseeable future amid large fiscal deficit, and how long MPC would like to hold loose policy stance while fiscal policy has chosen expansionary fiscal path for the medium term," said Soumyajit Niyogi, associate director at India Ratings and Research.  

All 10 economists and bond dealers in a Business Standard poll said the six-member monetary policy would exercise a pause on Friday, but the policy would be interesting to watch out for nevertheless. Analysts will be carefully watching out for cues for a whole host of issues as the country comes out of the pandemic grip and gets back to a high growth aided by a large part by base effect.  

“Any more repo rate cuts are now unlikely," said Gaurav Kapur, chief economist of IndusInd Bank.  

“Revival of nominal GDP growth, through higher and sustainable real GDP growth, will remain the main focus of both fiscal and monetary policy, in the next fiscal and beyond. A sizable fiscal impulse over this year and the next, which tries to balance public investments and healthcare needs with large subsidy spends, reduces the space for anymore monetary easing," Kapur said, adding that MPC would exercise caution as non-food core inflationary pressures are now building up and consumption demand is reviving even as easing food inflation would keep CPI close to 4 per cent. 

An RBI support in the face of huge borrowing numbers will become absolutely necessary, but the measures may not get spelt out in detail on Friday.  

"Beyond the assurances about managing the borrowing programme smoothly and maintaining adequate liquidity, the RBI may not want to spell out its proposed actions in detail. Going forward, OMOs and OTs will continue to be used more for managing yields, but the liquidity normalisation through variable rate reverse repo would continue," said Badrish Kulhalli, fund manager, fixed income, at HDFC Life Insurance.  

The banking system is running a liquidity surplus of Rs 6.47 trillion as the central bank kept the system awash with liquidity to keep the financial system running at a time when it had to manage borrowing of Rs 12 trillion by the centre in a pandemic year. The RBI recently announced Rs 2 trillion of variable rate reverse repo auction to slowly reduce this liquidity, but the central bank may have to reconsider that now.  

 

“Empirical evidence suggests that in a world where fiscal dominance is the rule, monetary policy response of the Central Bank must accommodate debt financing in its objective to attain a superior macro-outcome," said Soumya Kanti Ghosh, chief economic advisor to the State Bank of India group.  

“Beyond the policy rate adjustment, we now expect the focus to clearly shift to liquidity management through coordinated policy action of the RBI to accommodate the large debt financing of the Government through both conventional and unconventional liquidity measures like stepping up OMO, increasing held-to-maturity (HTM) limit and targeted refinancing,” Ghosh said. 

"RBI will continue to give assurances on accommodation of Govt borrowings but will maintain a status quo on rates. Very likely to increase their growth projections by factoring in the impact of fiscal stimulus," said Rupa Rege Nitsure, chief economist of L&T Finance Group. 

"While inflation eased in December, the outlook remains an area of concern. We expect inflation to average 4.6 per cent in FY22, and dip below the 4  per cent target only in a couple of months in the third quarter of fiscal 21-22. Accordingly, we expect an extended pause for the repo rate," said Aditi Nayar, principal economist at ICRA Ratings. "The stance is likely to be changed to neutral only after there is greater clarity regarding the durability of the economic recovery," Nayar said.