Monetary policy review: RBI may seek comfort in Rs 1 trn excess fund

Some market participants believe that it will have little impact on the bond market as it is only applicable for a short period of time

Market participants expect the Reserve Bank of India (RBI) to obtain a sense of ease when the liquidity surplus comes down to around Rs. 1 trillion.

The excess funds that banks parked with the RBI through the liquidity adjustment facility (LAF) was over Rs. 2 lakh in most of the days in August.

The participants said the central bank may implement corrective measures aimed at absorbing the excess liquidity from the system if the surplus remains above Rs. 1 trillion.

During the monetary policy committee (MPC) review announcement on Thursday, the RBI mandated that with effect from the fortnight beginning August 12, scheduled banks need to maintain an incremental cash reserve ratio (I-CRR) of 10 per cent on the increase in their net demand and time liabilities (NDTL) between May 19 and July 28.

This measure is intended to absorb the surplus liquidity generated by various factors, including the return of Rs. 2,000 notes to the banking system. The move will be reviewed by the central bank on or before September 8.

“The RBI considers the Rs. 1 trillion liquidity surplus as a neutral level of liquidity,” a dealer at a state-owned bank said. “They are not comfortable with anything beyond Rs. 1 trillion. They will continue to conduct variable rate reverse repo auctions (VRRR) and implement other majors until we reach there,” he added.

Over Rs. 1 trillion liquidity is expected to be mopped up on the incremental CRR move, RBI Governor Shaktikanta Das indicated at the post-policy conference on Thursday.

Some market participants believe it will have little impact on the bond market as it is only applicable for a short period of time.

“It will not affect the market much because it is a measure only for a month, in which the RBI has been sucking out the liquidity through VRRR auctions as and when the liquidity was surplus,” said Vijay Sharma, senior executive and vice-president at PNB Gilts. “It will not affect the short-term bonds majorly either. A 2-3 basis point movement can’t really be called an impact.”

On the other hand, some participants said the short-term rates on money market instruments like call money rates, treasury bills and commercial paper were likely to increase by 15-20 bps in the near term.

As of August 8, the aggregate liquidity within the system, comprising government balances and the LAF, reached nearly Rs. 3.5 trillion, according to a report by HDFC Bank.

Several contributing factors like the RBI’s intervention in the foreign exchange market, coupled with significant foreign investments in Indian equities and a more than expected return of Rs. 2,000 notes into the banking system, collectively contributed to an increase in the overall liquidity.

However, the excess liquidity in the system is expected to dip in coming months due to anticipated Rs. 1.5 trillion worth of advanced tax payments.

“Tighter liquidity conditions could imply some upward pressure on both credit and deposit rates as transmission of past rate hikes improves. We expect a liquidity surplus as measured by the LAF balances to average between Rs. 1 trillion and Rs. 1.5 trillion going forward in Q2FY24,” economists of HDFC bank said in a report.