The Reserve Bank of India (RBI) will focus on squeezing excess liquidity from the banking system in its monetary policy meeting on 5-6 April while keeping policy rates unchanged and retaining its neutral stance, according to a Mint survey.
The surge in cash deposits following demonetisation resulted in liquidity rising to Rs4 trillion in March from Rs2 trillion in January. Announcing the 8 February policy, the central bank said surplus liquidity should decline with progressive remonetisation, but the abundant liquidity with banks is now expected to persist into the early months of fiscal 2017-18.
“We don’t expect any change in the monetary policy stance as growth-inflation dynamics haven’t changed much since February. The main focus is on what the RBI does with the excess liquidity in the system and what tool it uses to make system liquidity more consistent with its neutral monetary policy stance," said Sonal Varma, managing director and chief India economist, Nomura Holdings.
A majority of economists expect RBI to introduce a Standing Deposit Facility (SDF) framework to help drain surplus cash from the system without the need for any collateral. This facility, which was first introduced in the Urjit Patel committee report released in January 2014, allows banks to park their excess liquidity with the central bank with the exception that it does not have to provide any collateral in exchange.
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Economists believe that SDF is a better option compared with a permanent liquidity measure like a hike in the cash reserve ratio (CRR), or portion of deposits that banks have to maintain with RBI.
“We do not expect the central bank to increase the CRR from the current level of 4% to absorb the surplus liquidity as that would deter banks from reducing... lending rates, delaying the transmission of past monetary easing," said Naresh Takkar, managing director and group CEO, Icra Ltd.
“In contrast, open market sales of RBI’s holdings of government securities that stood at Rs7.5 trillion on 10 March 2017 could be utilized to absorb what is turning out to be a prolonged liquidity surplus. Such sales of bonds would also help to absorb the rupee liquidity generated vide any purchases of foreign exchange, simultaneously shoring up the country’s forex reserves and slowing the sharp appreciation of the rupee," he added.
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Matters have become more complicated for RBI because of the rupee strengthening by 5.2% against the US currency since 23 January. A strong rupee will force the central bank to buy dollars, adding more rupee liquidity to an already awash banking system, stoking inflation.
Eleven out of 13 economists surveyed by Mint expect the central bank to maintain its 4% inflation target by March 2018 in the first meeting of the monetary policy committee in the current fiscal year, leaving little room for a cut in policy rates this year.
In its February policy, RBI had projected retail inflation at 4-4.5% in the first half of the current fiscal and in the range of 4.5-5% in the second half. Two of the 13 expect RBI to sound dovish, signalling the possibility of a rate cut in the coming months.
“While there is no scope for any policy rate cut in the upcoming monetary policy, a fragile domestic recovery combined with the tailwinds coming from global economy may prompt the RBI at least to revisit its stance of neutrality," said Rupa Nitsure, group chief economist, L&T Finance Holdings Ltd.