More tightening expected from RBI as liquidity eases

Observers suggest temporary CRR rise or increase of ECR rate as options

Despite several measures by the central bank since July 15 to tighten liquidity in the money market so that short-term rates rise, the efforts are yet to yield the desired result.

Banks’ borrowing from the Marginal Standing Facility (MSF) was as low as Rs 2,200 crore on Friday, as compared to Rs 25,920  crore on Monday. The easy liquidity situation has led to overnight rates falling below the MSF rate of 10.25 per cent.

The Reserve Bank of India (RBI) had raised the marginal facility rate by 200 basis points to 10.25 per cent while capping banks’ borrowing from the daily Liquidity Adjustment Facility (LAF). Banks are allowed to avail up to only 0.50 per cent of their net time and demand liabilities from the LAF window.

These moves were aimed at making the rupee expensive, to curb speculation in the foreign exchange market which was further weakening the currency.  Since the July 15 step, the currency has weakened 1.6 per cent against the dollar. On Monday, though, it ended 0.4 per cent stronger, to close at 60.88/dollar after recording an all-time closing low on Friday.

“Importantly, if the central bank believes that higher short-term interest rates are important in curbing volatility in the forex markets, it might introduce more measures to tighten liquidity,” Standard Chartered Bank  said in a note to its clients. “While it is difficult to identify precisely the drivers of such a narrowing (liquidity deficit), we believe unusually high government spending a likely cause.”

According to market participants, RBI might lower the cap for banks’ borrowing under the LAF further; also, a temporary rise in the cash reserve ratio (CRR) could be an option. CRR is the proportion of deposits that banks need to park with RBI as cash. “Rates have not increased much because credit is not picking up and also due to these liquidity tightening measures, speculative activities and investments having come down. As a result, it enables banks to be comfortable with liquidity,” said Ramesh Kumar, senior vice-president (debt market), Asit C Mehta Investment Intermediaries.

The central bank is yet to use any monetary policy tool for tackling the exchange rate but RBI governor D Subbarao indicated that if the long-term rates increase as a result of the measures, then that is part of the process.

The rupee has depreciated 12.15 per cent against the dollar since this financial year began on April 1, due to local and global factors. While the record high current account deficit – 4.8 per cent of gross domestic product in 2012-13 – is one  factor for the rupee’s sharp depreciation, concern over tapering of the US Federal Reserve’s asset buying programme has made foreign investors exit from emerging nations, including India.

Among other steps that could be contemplated by RBI are revising the export credit refinance rate and selling short- term securities. Banks’ borrowing from the facility has increased by about Rs 27,000 crore from this facility since the July 15 liquidity measures. Banks avail these funds at the repo rate, currently 7.25 per cent. This rate could be aligned with the MSF rate.

“RBI might wait before tightening liquidity further and see the combined factors like currency in circulation with the public, the effect of spot-dollar intervention and some let-up in government spending. But if RBI is watching just the overnight call rates and drawdown from the MSF in the near term, it might come up with more measures,” said Suyash Choudhary, head-fixed income, IDFC Mutual Fund.