Informist, Tuesday, Sep 12, 2023
By Nishat Anjum and Aaryan Khanna
MUMBAI/NEW DELHI – The Reserve Bank of India's decision to withdraw the incremental cash reserve ratio in a phased manner did not surprise the market, but it will keep liquidity tight and money market rates high till early October, bankers and market participants said.
In August, the RBI had imposed an incremental CRR of 10% only on the increase in the net demand and time liabilities of scheduled banks between May 19 and Jul 28; this came into effect from the fortnight starting Aug 12. This move had drawn out over 1 trln rupees from the banking system, which will now trickle back in over the next few weeks.
On Saturday, the RBI began the rollback by releasing 25% of the amount parked with it. The central bank will release another 25% on Sep 23, and the remaining 50% on Oct 7, according to the roadmap unveiled last week. Market participants expect liquidity to normalise just before the final tranche is credited to banks, after a topsy-turvy September.
Treasury desks had almost uniformly expected the additional CRR to stay either in whole or in part through September, though estimates differed whether the incremental CRR would be maintained at 10% or be cut to around 5% of the rise in net demand and time liability in the period. The RBI essentially split the difference for the Sep 9-22 fortnight, officials said.
"You don't introduce a tool like incremental CRR and then let it go immediately," an official at a primary dealership had said last week. "They will wait to get a complete hang of liquidity before they let it go."
Even as incremental CRR gets phased out, banks are faced with the daunting task of managing liquidity amidst routine outflows from the banking system. Starting this week, there will be outflows on account of payment of advance tax for the September quarter and next week there will be outflows for the goods and services tax.
Advance tax payments will lead to outflow of over 1 trln rupees while GST payments may drain out around 800 bln rupees from the financial system, bank officials estimated.
"As far as we are concerned, we have sufficient liquidity. We will be able to manage even with the outflows," said a treasury head at a state-owned bank. "Their (RBI's) aim is for higher rates, and very tight liquidity suits that. One fortnight would not have been enough, they would want tight conditions till October-end."
Other bank officials also insist there was sufficient liquidity in the banking system despite the outflows, even though they were nervous on Friday as to how much CRR would have to be maintained for the next fortnight.
The RBI had put lenders in a dicey situation by conducting a 14-day variable rate reverse repo for 500 bln rupees, before announcing the roadmap for the withdrawal of the incremental CRR. The reverse repo tender saw a muted response, with banks parking only 186.70 bln rupees under it, mainly due to the uncertainty about near-term liquidity.
"The RBI seems comfortable with liquidity either in a 1-trln-rupee surplus or deficit, and they have enough tools to monitor and do so," said Sudarshan Nambiar, head of trading at YES Bank. "A VRR (variable rate repo auction) will be there if needed, it's on the table."
The RBI most likely opted for a phased withdrawal after noting the steady movements in overnight call money market rates during the two fortnights when the 10% incremental CRR was imposed, treasury officials said. Overnight money market rates had spiked after the incremental CRR was announced but eased soon after the government's month-end spending for salaries and pensions began in late August and continued into early September.
The only hitch seen was liquidity slipping into a deficit again in September, and this time for over a week instead of the three days of deficit in August.
For the first time in the current financial year that began on Apr 1, liquidity in the banking system slipped into deficit on Aug 22 due to the double whammy of the incremental CRR and monthly outflows on account of the goods and service tax.
With the outflows lined up in the coming weeks, liquidity is expected to be in deficit starting Sep 18, when the outflows hit the banking system, till at least Sep 22 and slightly beyond. During this time, there will be other outflows as well – payments for gilts at the weekly auctions, which would further weigh on the liquidity surplus.
"We expect that the liquidity will turn into a deficit zone of 300-500 bln rupees next week, projecting regular weekly spending by the government," said Upasna Bhardwaj, chief economist at Kotak Mahindra Bank. "It should only be in deficit for about a week, after which the month-end spending would bring it back comfortably into surplus."
While the government's month-end spending would improve liquidity, a large surplus is unlikely to build up in September as banks push credit to dress their accounts near the quarter-end, bank officials said.
Despite the phased withdrawal of the incremental CRR, market participants remain concerned that the weighted average call rate – the operative tool of monetary policy – could hover near the Marginal Standing Facility rate of 6.75% rather than the policy repo rate of 6.50% for the rest of the month. This reflects traders’ concerns of a proxy rate increase by the RBI between its August and October monetary policy reviews using liquidity tools, without a formal rate hike.
"Since the ICRR (incremental CRR) has been announced, it has driven up rates, so effectively you can call it a temporary rate increase since then," Bhardwaj said.
Some interest rate traders also paid fixed rates in overnight indexed swaps trades expecting the high overnight rates to persist, with the liquidity situation in peril of being tight or in deficit over the next three weeks at least. The Mumbai Interbank Offered Rate forms the floating leg of the OIS contract and was set at 6.74% today.
Today, the one-year swap rate ended at an over six-month high of 7.10% while the five-year contract closed 6.85%, the highest since Nov 7.
With the expectation the MIBOR rate will likely stay around the MSF rate of 6.75% until the end of the month, traders were comfortable with short-term swap rates – an indicator of domestic rate expectations – rising, dealers said. Others were sceptical of this view.
"I don't think the ICRR (incremental CRR) has any bearing on broader markets as it was on expected lines, either in gilts or swaps, which are driven by positioning that is hard to understand right now," Nambiar of YES Bank said.
The silver lining on the cloud of uncertainty about liquidity and rates is the relief from the clear timeline conveyed by the central bank. This will enable a smoother discovery of money market rates as they navigate daily mismatches in cash between banks, officials said.
The requirement to maintain an incremental CRR will now apply, partially and in a reducing manner, till Oct 7, after which the usual rise in cash in circulation associated with the festival season could pull down banking system liquidity organically. RBI Governor Das had said while announcing the measure that the incremental CRR was implemented "with a view to returning the impounded funds to the banking system ahead of the festival season."
The central bank would prefer tight liquidity to prevent demand-led inflationary pressures building up in the economy, bank officials said. The last time the CPI inflation print came in at or below the RBI's target of 4% was in September 2019.
"Calibrated phase out of ICRR (incremental CRR) is a justified move as central bank aligned the withdrawal…with the advance tax and GST outflows and ensured liquidity in the system ahead of festive season," said V.R.C. Reddy, head of treasury at Karur Vysya Bank.
According to an Informist poll, India's retail inflation is seen at 7.0% on year in August, easing from a 15-month high of 7.4% in July.
The RBI's use of innovative methods and tools in its conduct of monetary policy may once again spring to the fore if liquidity grows into a large surplus near the end of October. Its regular 14-day reverse repo and repo operations are likely to continue in the interim to keep liquidity firmly under control, the officials said. End\
Informist Media Tel +91 (22) 6985-4000
Send comments to feedback@informistmedia.com
© Informist Media Pvt. Ltd. 2023. All rights reserved.