Repos Auctions May Make Interest Rates More Realistic

The cut-off rate at the auction is expected to be fixed at 4 per cent. This will result in the call money rates tightening slightly to reach more sustainable levels than the 2.5 per cent that it is at now.

The yield on the 91-day paper, which crashed to 6.94 per cent, is also likely to move slightly upward with the withdrawal of liquidity from the system.

Depending upon how much money is put into this auction (the market is expecting a subscription to the tune of Rs 2,000 crore) and the ones which are to follow, the apex bank will be able to put a tag on availability of liquidity in the system. And the rates at which banks make their bids will help the RBI to assess expectations on interest rates.

Some banks are likely to place their bids beyond 4.6 per cent at the auction, because these are the rates which they would get by investing in on-tap treasury bills for fourteen days.

On November 9, there will be another 0.5 percentage point cut in the cash reserve ratio requirement. This will release around Rs 2,000 crore into the system, and will prompt the central bank to once again announce a repos auction.

This time around, the auction will be for fourteen days, instead of the present four days. The repos should also help in controlling inflationary implications of excess money supply. It is not the first time that the Reserve Bank is resorting to a repos auction for withdrawing liquidity from the system. The same means had been used in the early 90s era of ample FII inflow, when almost every week, the cebtral bank was announcing a repos auction. Moreover, it also used it for purposes of window dressing.

All said and done, while withdrawing excess liquidity in an easy money situation seems a good idea, does the RBI have a similar solution in times of a liquidity crunch?

Will it, for instance, enter into reverse repos auctions with banks directly when the money situation tightens? The market will have to wait and watch for that one.