Monetary policy review: Liquidity step was needed, say bond dealers

The higher quantum in variable rate reverse repo (VRRR) window did not come as a major surprise for the bond market, but the dovish tone of the Reserve Bank of India (RBI) had undertones of normalisation.
 
The RBI stopped the Government Securities Acquisition Programme (G-SAP), through which it has infused Rs 2.2 trillion of liquidity in the system. It has purchased Rs 17,000 crore of bonds from the market through its open market operation (OMO) route. The OMOs will continue and so will Operation Twist, in which the RBI simultaneously buys and sells equivalent amounts of bonds. If need be, G-SAP could also be back, RBI officials said.
 
But chances of G-SAP coming back are remote as liquidity overhang is close to Rs 13 trillion, according to the RBI policy document.  The bond yields rose after the policy. The 10-year bond yields closed at 6.3178 per cent, a level last seen on April 17, 2020, from its Thursday’s close of 6.267 per cent.
 
The RBI conducted a VRRR of Rs 4 trillion on Friday, the cut-off of which came at 3.99 per cent. RBI Deputy Governor Michael Patra explained that the central bank is still in passive liquidity mode and accepting what the market was offering. The aim for the RBI was to move to an active mode of liquidity management, Patra said.
 
“The markets will gradually shift to consider policy repo rate as operating rate from earlier anchor of reverse repo rate. The money market rates will see 30-35 basis point rise, while not much uptick is expected at the long end,” said Ajay Manglunia, managing director, JM Finance.
 
The fortnightly VRRR started at Rs 2.5 trillion on August 13, and increased by Rs 50,000 crore in each instalment till it reached Rs 4 trillion on September 24. Continuing with that incremental amount, the VRRR will reach Rs 6 trillion by December 3, Governor Shaktikanta Das told reporters.

 Some in the market, however, were surprised.
 
“The biggest surprise was the complete removal of G-SAP,” said Pankaj Pathak, fund manager-fixed income, Quantum Mutual Fund.
 
But the bond market participants also could connect with the RBI governor.
 
“You cannot equate US taper with RBI’s curb on G-SAP. Instead of G-SAP, OMO and OT will continue, and the RBI governor halted between his prepared speech to explain that there should be nothing to worry,” said Jayesh Mehta, head of treasury at Bank of America.
 
Bond market participants say the VRRR serves purposes beyond liquidity management.
 
“The RBI is clearly carving out two reverse repo windows. Because of the liquidity overhang in the daily fixed rate window, overnight rates are continuously trading lower than the reverse repo rate. The higher amounts under the variable rate window will help in correcting this and help push up money market rates,” said A. Prasanna, chief economist of ICICI Securities Primary Dealership.
 
Besides, bond dealers say too much of liquidity in the overnight window may also create system instability and stroke inflation.
 
Gopal Tripathi, head of treasury, Jana Small Finance Bank, said through the liquidity management steps, the RBI was preparing the market to adjust to higher reverse repo rate.  Bond dealers expect the bond yields to remain at around the present level, or rise by 5-10 basis points following cues from US treasury.