2023-08-16 19:15:37
The RBI may not increase the repo rate as it ascertains the durability of high food prices while seeing the impact of previous rate hikes work their way through the economy, which faces threats from a weak external environment.
The central bank can, however, bolster transmission of its policy actions and prevent borrowing costs from turning cheaper by keeping a tight leash on banking system liquidity.
“In the near term we expect RBI will maintain its focus on liquidity management to ensure liquidity remains close to neutral and the interbank weighted average call rate remains at or a tad above the repo rate. As such we see a high probability that RBI may continue with the incremental CRR announced on August 10, which is expected to be reviewed on September 8,” said Upasana Chachra and Bani Gambhir, economists at Morgan Stanley.
Surplus liquidity in the banking system has risen sharply over the past couple of months due to the return of Rs 2,000 notes to banks, a higher-than-budgeted surplus transfer from the RBI to the government and overseas inflows. In August, the daily average amount of surplus funds parked by banks with the RBI was at a 14-month high of Rs 2.5 lakh crore.
Surplus banking system liquidity typically drags down money market rates and therefore cost of funds in the economy. RBI governor Shaktikanta Das said last week that excessive liquidity poses risks to price stability as well as financial stability. The incremental CRR of 10% imposed on the increase in deposits from May 19 to July 28 is seen as impounding funds worth around Rs 1.1 lakh crore.“In the current environment of significantly above target inflation, driven by food, but amid signs of core inflation easing, we think risks are skewed towards the RBI extending its temporary incremental cash reserve ratio or tightening liquidity through other means,” said Nomura economists Sonal Varma and Aurodeep Nandi.
With the unfavourable inflation development seen ruling out rate cuts in the foreseeable future, government bond yields, the benchmarks for other borrowing costs in the economy, are seen rising. The current quarter is a challenging one for the bond market, given extremely heavy net supply of government securities.
“While markets might take some comfort from the softer core inflation print, we think the sheer extent of the spike in headline inflation is likely to push up the 10-year bond yield this week… the 10-year is likely to make its way above 7.25%,” HDFC Bank’s treasury research team wrote.
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