Rajan may partially rollback liquidity tightening steps

MSF rate may be cut by 50 bps; LAF borrowing cap hike to 1% seen; OMOs to resume

With the rupee recouping most of its losses that it had incurred since May, banks are looking for rollback of liquidity tightening steps, at least partially, as tight money market conditions are impacting their profitability.

“The US Fed's decision gives more elbow room to RBI and they may roll back partially the liquidity tightening measures. However, a cut in key policy rates may not happen due to rupee volatility and inflation risks,” said Radhika Rao, economist, DBS Bank.

 

Since mid-July, the central bank unleashed several liquidity tightening measures including capping banks’ borrowing from liquidity adjustment at 0.5% of their net demand and time liabilities which forced banks to avail the marginal standing facility window for their daily requirements. Along with capping LAF borrowing, the MSF rate were hiked by 200 bps to10.25%. These measures ensured that short term rates adjust to the MSF rate so that the cost of money becomes dearer. The liquidity tightening steps were aimed at curbing speculation in the foreign exchange which was adding to the rupee weakness. 

 

Now that falling momentum of the rupee halted and US Fed’s decision to continue with the planned monthly purchase of bonds will also boost the emerging market currencies going forward, market participants now expect the central bank cut the MSF rate by at least 50 bps.

 

“We expect the RBI to reduce the MSF rate by 50bp to 9.75%. We believe it will likely phase it out altogether in December once the FX raised by the FCNR(B) deposit-cum-swap facility is fully known on Nov. 30,” said Indranil Sengupta, India Economist, Bank of America Merrill Lynch.

 

Market participants are also expecting banks will get more space for borrowing under the liquidity adjustment facility. Now, banks are only allowed to borrow 0.5% of their NDTL from the LAF window, and the expectation is this will hiked to 1%. Banks pay 7.25% for funds borrowed from LAF as compared to 10.25% under MSF.

 

Banks have been borrowing around Rs 1 lakh crore daily from the MSF window in recent times. Such high borrowing from MSF has increased banks’ cost of funds and put profitability under pressure. In addition, the bond market players are expected open market purchases of bonds to resume which would also help to keep the yields on government papers.