Mumbai: Barely a week before it unveils the next monetary policy, India’s central bank hasn’t let up on the barrage of measures it has unleashed to drain every last bit of loose cash floating around in the banking system, in a bid to shore up the rupee, the worst-performing currency in Asia ex-Japan this year.
One of the latest measures was dubbed an effective interest rate hike by bank economists.
The Reserve Bank of India (RBI) on Tuesday scrapped the Rs.75,000 crore cap on bank borrowings through the daily liquidity adjustment facility (LAF), through which banks access money to meet short-term needs, and instead set a daily limit on borrowings by individual banks, effectively cutting by half the amount they can borrow from its repo window.
Banks have also been asked to set aside an increased amount through the cash reserve ratio (CRR).
“Effective from the first day of the next reporting fortnight, i.e., from 27 July 2013, banks will be required to maintain a minimum daily CRR balance of 99% of the requirement...up from a minimum of 70% earlier,” RBI said in a press release on its website. They could take this up to 100% on the fortnightly reporting day.
Both these measures are likely to send short-term interest rates surging as they effectively increase the funding cost of borrowers, at least in the next few months, bankers and economists said.
Each bank has now been allowed to borrow 0.5% of their net demand and time liabilities (NDTL) effective Wednesday. Under the Rs.75,000 limit announced on 15 July, banks’ borrowing limit had been fixed at 1% of the system’s NDTL, or banks’ total deposit base.
The recently announced measures are aimed at containing “the volatility in the foreign exchange market”, RBI said.
“These measures have had a restraining effect on volatility with a concomitant stabilizing effect on the exchange rate. Based on a review of the measures, and an assessment of the liquidity and overall market conditions going forward, it has been decided to modify the liquidity tightening measures,” RBI said.
The rupee has dropped 9% in the past three months against the dollar. The currency hit a record low of 61.2125 on 8 July, but has since recovered to close at 59.76 per dollar on Tuesday.
The latest measures will “tighten” banking and drive overnight rates “towards the 10.25% marginal standing facility (MSF) rate”, said Saugata Bhattacharya, chief economist at Axis Bank Ltd.
MSF is an emergency liquidity facility that banks use to borrow in case they fall short of cash for their daily needs. Under this facility, banks used to borrow money at the repo rate plus 1%, or at 8.25%. However, effective 16 July, banks were asked to pay two percentage points more, or 10.25%, to draw money through the window.
“With these new measures I think at least Rs.39,000 crore will have to be borrowed from the MSF facility, which will push short-term rates higher. Also, the fact that banks have to keep a higher amount of minimum daily balance in CRR effectively means liquidity will be squeezed further,” Bhattacharya said, describing the move on CRR as “effectively a hike”.
RBI also announced the auction of 28-day and 56-day government bills worth Rs.3,000 crore each on Thursday.
The short-term bond sales were announced after the central bank had to cancel two auctions of treasury bills on Thursday because investors demanded higher interest rates on them.
Less than one-fifth of the Rs.12,000 crore of government bonds it had wanted to sell as part of its recent moves to reduce liquidity attracted buyers, RBI auction results showed.
By offering short-term paper, the RBI has made it clear that it doesn’t want to push up long-term bond yields, said N.S. Venkatesh, treasurer at IDBI Bank Ltd.
“The auctions are intended at curbing the temporary volatility in the forex market by managing the liquidity. As a result of the central bank’s actions, rupee will hold the current levels and will marginally appreciate in the approaching sessions,” Venkatesh said.
The latest RBI measures will push up the overnight borrowing rates to 10.25% by the end of this week, said A. Prasanna, chief economist at ICICI Securities Primary Dealership.
“The combined impact of banks’ restricted ability to borrow and increased CRR daily balance requirement will push rates higher. But Tuesday’s steps by RBI will help to resolve the confusion, which was present in the money markets last week about RBI’s intention and logic regarding the recent steps to curtail liquidity and shore up rupee,” Prasanna said.
The central bank may have been forced to tighten liquidity after the interbank call money rate—the rate at which banks borrow short-term funds from each other—averaged 6.75% since 17 July, lower than the 6.85% average before the RBI moves. On Tuesday, call money rates touched a high of 7.35% in the interbank market before closing at 6.50%.
However, the average yield on one-year commercial paper has already risen to 9.98% since 17 July from 8.82% between 1 and 15 July.
Bhattacharya of Axis Bank said banks had insulated themselves from RBI moves earlier because they had borrowed a record Rs.2.16 trillion from the daily liquidity adjustment facility window a day before the Rs.75,000 crore borrowing cap came into effect.
Both Prasanna of ICICI Securities Primary Dealership and Bhattacharya of Axis Bank expect short-term interest rates to go up, effectively raising borrowing costs.
“Some rates may go up by even as high as 1% immediately on Wednesday, mainly because banks have to keep aside a higher average of their deposits as CRR,” Bhattacharya said.
Venkatesh of IDBI said the immediate reaction would be a spike in short-term rates and bond yields.
“The stringent measures are aimed at enforcing liquidity management discipline among banks. With the higher requirement for daily maintenance of CRR balance, banks’ liquidity management will be very tight as they have only a narrow band left,” Venkatesh said, referring to the RBI’s move of hiking the CRR daily balance requirement to 99% from 70%.