BackRBI restricts liquidity to shore up rupee
RBI places daily limit on how much banks can borrow from it; some bankers see moves as indirect rate hike
Premium(Pradeep Gaur/Mint)
Mumbai: The Reserve Bank of India (RBI) late on Monday restricted banks’ access to easy money in a bid to prevent speculation in the currency market, although the move will also effectively increase borrowing costs.
The central bank on Monday placed a daily cap on how much banks can borrow from it. RBI, which until recently had been buying bonds to aid liquidity, also said it will sell bonds worth ₹ 12,000 crore in the secondary market on 18 July to suck out liquidity from the banking system.
The rupee fell to its lifetime low of 61.21 a dollar on 8 July as speculators raided the currency market even as the dollar strengthened against major currencies globally. So far this calendar year, the rupee has fallen close to 8.5% against the dollar. RBI has already banned banks from proprietary trading in the currency derivatives segment, though they can trade on behalf of their clients.
RBI on Monday fixed the borrowing limit for banks at 1% of the system’s net demand and time liabilities, or banks’ total deposit base. The overnight borrowing limit for the system now stands at ₹ 75,000 crore for the entire banking system.
“The allocation to individual banks will be made in proportion to their bids, subject to the overall ceiling," RBI said in its statement.
This borrowing limit will come into effect from 17 July.
However, in case any bank falls short on liquidity, it can get money from the central bank at a much steeper rate and under an emergency liquidity facility known as the marginal standing facility (MSF).
Under this facility, banks used to borrow money at the repo rate plus 1%, or at 8.25%. However, effective immediately, they will have to pay 2 percentage points more, or 10.25%, to draw money under this facility.
Thus, the MSF now stands at 300 basis points above the repo rate of 7.25%. A basis point is one-hundredth of a percentage point.
So far banks had not touched the MSF as they had enough government bonds with them to borrow from the central banks’ overnight liquidity window. Banks have a bond reserve that is about 5% above their statutory limit of 23% of the deposit base, which they used to pledge with RBI for extra liquidity.
However, with this severe restriction coming into place, banks will have no other option but to borrow money at a steep rate.
“The hike in MSF is clearly to make the cost of carry over dollar more expensive. They want to deter traders from going short on the rupee. With the US Fed (Federal Reserve) likely to taper its quantitative easing and US yields going higher, the rupee, which is a higher-yielding currency, has lost some of its attractiveness," said Ashish Vaidya, head of fixed income, currency and commodity trading at UBS India.
RBI’s statement was clear that the excess liquidity in the system is partly responsible for the rupee volatility.
“The exchange rate pressure also evidences that the demand for foreign currency has increased vis-à-vis that of the rupee in part because of the improving domestic liquidity situation," RBI’s late-evening statement said, explaining the reason for the liquidity reducing measures.
Some bankers see Monday’s measures as an indirect rate hike. RBI moved to an easy interest rate regime in April last year after months of raising interest rates to keep inflation in check. Critics of the central bank have maintained that the tight interest regime was in part responsible for the slowdown in the economy.
“This is a signal of rate tightening from RBI. This was the only way the central bank could do it because the government is sensitive to interest rate hikes at a time when the country’s growth is slowing," said a senior banker who did not want to be named.
“MSF is an indirect rate hike, and limiting the liquidity in the banking system will curb banks’ access to cheap money which was used to speculate in the forex market," said the banker.
The RBI measures came after its governor D. Subbarao had an emergency meeting with finance minister P. Chidambaram in the morning to discuss the rupee’s volatility.
“The central bank cannot hike rates because domestic growth is faltering. These measures will make it more expensive to short the rupee. I think these measures will help and we could see some more measures like a international bond issuance," Vaidya of UBS said.
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