RBI, bond market players discuss liquidity strategy as surplus dwindles

RBI asked for mkt views on BoP, impact of 75-bps rate hike by US Fed

At a meeting earlier this week, between officials of the Reserve Bank of India and select participants in the government bond market, a key issue that was discussed was the central bank’s future strategy on liquidity, given that surplus funds in the banking system have reduced sharply, sources said.

At the interaction, which was held prior to the next monetary policy statement on September 30, market participants and the central bank officials were said to have spoken about the feasibility of the RBI continuing with consistent variable reverse repo auctions.

“A key point in the meeting with the RBI was liquidity – basically the liquidity surplus has come down sharply and in a couple of months we could be seeing the system sustaining around the neutral level of liquidity,” a source aware of the development said.

“In such a situation, it would obviously not be feasible for the RBI to continue draining liquidity through VRRR (variable rate reverse repo) operations. There is a possibility of us seeing more balanced operations in both directions – repo auctions as well as reverse repos,” the source said.

Surplus liquidity in the banking system has been decreasing sharply for the past few months due to the RBI’s aggressive interventions in foreign exchange market and a sharp pick-up in credit growth.

The average daily absorption of surplus funds by the RBI from banks so far in September is at about Rs 1.13 trillion, against the average of Rs 1.2 trillion in the previous month. The RBI’s average daily absorption of excess liquidity was Rs 3.8 trillion during June-July versus Rs 5.5 trillion in May and Rs 7.4 trillion in April.

Another topic of discussion was the external situation, with the RBI officials said to have taken feedback from market participants about their estimates for India’s balance of payments and current account deficit. The central bank officials were also said to have enquired about the impact that a 75-basis-point rate hike by the US Federal Reserve could have on the domestic market.

“As was the case even two months ago, the RBI’s key focus area seems to be ensuring stability in the rupee,” a source said.

“They have their own estimates for the CAD. What the RBI wants to have surety on is that market movements are not too volatile in the aftermath of the Fed tightening,” the source said.

The Federal Reserve is likely to raise interest rates by at least 75 basis points at its policy meeting this week. The US central bank has already raised interest rates by 225 basis points so far in 2022, leading to substantial strength in the dollar and consequently weakness in other currencies across the board.

The rupee, which has weakened close to 7 per cent against the dollar so far in 2022, touched a fresh low of 80.13 to the greenback on August 29. The Indian currency has suffered less than several other currencies due to heavy interventions by the RBI in the form of dollar sales.

From about $631.53 billion as on February 25, the RBI’s headline foreign exchange reserves have declined to $550.87 billion as on September 9. Foreign exchange reserves, at $553.1 billion on September 2, were equivalent to nine months of imports projected for 2022-23, the RBI said.