INR550bn OMOs to Keep Liquidity Balanced during 2HFY17

India Ratings and Research (Ind-Ra), according to base case scenario, expects another INR550bn of durable liquidity needs to be infused through open market operation (OMO) purchases in 2HFY17, over and above INR1.05trn in 1HFY17. Ind-Ra's base case scenario is built on RBI's stated objective of neutral liquidity, which ensures minimal shortages as well as minimal surpluses. Hence, any preference towards considerable excess in liquidity will be adjusted through durable liquidity creation or OMO purchases. Similarly, surge in Fx flows may not necessitate permanent sterilization in the near-term.

BoP, CIC Surprises or Change in Reserve Bank of India (RBI) Strategy could lead to Higher OMOs: Since INR1trillion of OMOs has already been conducted during 1HFY17, necessity of similar amount of OMO in 2HFY17 will only be limited to certain conditions. Higher than expected INR550bn amount of OMO purchase in 2HFY17 would be contingent upon i) subdued net forex flows, or lower than estimated17.4bn BoP surplus ii) sharp rise in currency in circulation (CIC) against tepid growth in nominal variables iii) RBI continuing to maintain high surplus liquidity in the interbank market against the stated strategy for neutral liquidity.

 

Healthy BoP Surplus will be Major Contributor to Reserve Money Creation: Ind-Ra, after financing of the current account deficit (CAD), expects the capital inflows to add nearly USD17.4bn (INR1.18trn) to the forex reserve in FY17. These accretions take into account the FCNR (B) redemptions. According to the latest BoP data available, USD7bn had been added to the forex reserves till August 2016.

Rise in CIC to Remain Limited: Growth rate in CIC for the current year is likely to be restricted by multiple factors; such as drive against declaration of unaccounted wealth which could bring back large amount of cash into the system. An increase of 13%yoy RM as against similar growth in FY16 (13% yoy as on 18th March 2016) could reduce large (another INR1trn) requirement for OMO.

RBI to Keep Adequate Interbank Liquidity: Ind-Ra's prognosis suggests that the urge for maintaining high surplus in the systemic liquidity will reduce after FCNR (B) redemption is over by November. Further, there may be legitimate reasons to retain the appetite for OMO purchase in the next fiscal ahead of limited room for the incremental rating action. This will support policy makers to maintain an accommodative strategy in sync with the RBI's accommodative stance. Otherwise absence of rate action or OMO purchase may exert undue pressure on yields during FY18, limiting the efficacy of RBI's accommodative monetary policy transmission.

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