RBI prefers tight leash on cash

RBI prefers tight leash on cash

Mumbai: The Reserve bank of India (RBI) will keep cash conditions tight in coming weeks to keep a lid on inflation expectations, sources at the Reserve Bank of India (RBI) said, a strong indication that it will keep policy rates on hold until its next review in late July.

A big chunk of cash left India’s banking system this month when the government auctioned telecom licences, tipping the banking system into a net deficit position.

Banks which had been placing their surpluses with the central bank every day turned borrowers. The banking system was on average borrowing around Rs500 billion ($10.8 billion) every day in June, a big swing from a surplus of Rs500 billion until early May.

That tightness, however, takes some of the pressure off the RBI from having to raise rates before a 27 July meeting to keep a lid on inflation that has accelerated into the double digits. One deputy governor of the central bank said on Monday the probability of an off-cycle rate increase was very low, given the daily stream of economic developments globally and in India.

“Probability of rate action before policy is very low," said deputy governor K.C. Chakrabarty, who is not directly linked to monetary policy at the RBI but still has influence on the board.

Central bank sources also told Reuters the RBI is comfortable with the cash strain, which acts as a brake on inflation.

“RBI would like to keep liquidity on the tighter side going ahead as it helps in inflation control," a RBI official said. “There is no liquidity stress visible on market rates. The call rate has not gone up sharply above the repo rate," the official said.

However, RBI deputy governor Subir Gokarn said recently the central bank would take steps to ease the cash strain if existing measures do not have their desired effect, and investors appear to be reading those remarks at face value -- perhaps mistakenly.

“What he meant was in case call rates go through the roof, or there is a large volatility in short-term rates then we could take some measures," the central bank source said.

Market bets on easier cash

The interest rate swap market does not suggest a sustained period of tight liquidity. The overnight floating rate benchmark for swaps, the MIBOR, is at 5.5% -- above fixed rates for tenors ranging up to 11 months.

Three-month certificate of deposit (CD) rates last week fell to around 6.30% from 6.45% in early June, Thomson Reuters data show.

Cash conditions tightened this month, pushing up the call money rate to a three-month high of 5.50%, a quarter point higher than the repo rate at which banks borrow from the RBI.

Outflows towards the 3G and broadband spectrum licences totaled $21.6 billion, with a further $7.6 billion going out as advance tax payments this month -- a hoard that New Delhi may not be able to spend fast enough to get that back into circulation.

That, coupled with the RBI’s reluctance to taking more steps to infuse cash given inflation worries, will mean the shortfall in liquidity will persist into July. Banks borrowed Rs829.15 billion on Thursday from the RBI’s daily repo window, the highest since cash tightened in June.

“We may continue to be in liquidity deficit mode for most of July as government spending has not been very high," said Anindya Dasgupta, head of treasury at Barclays Capital in Mumbai. “I don’t expect the spending to pick up that much in July."

Banks are also barely using existing funding windows offered by the RBI, an indication that funding is not overly strained.

For instance, the RBI offered to buy back bonds worth Rs200 billion in the past two weeks, but banks tendering bonds demanded such high prices that it managed to buy back only Rs91 billion worth of paper.

“If banks indeed needed money, they would have sold the bonds to us at market levels. But they are not desperate," the RBI official said.

To some extent, the relative dovishness in the market stems from RBI governor Duvvuri Subbarao’s comments indicating he is not moving from the bank’s calibrated exit stance.

The effective rate for markets has moved up from the reverse repo to the repo, Subbarao said on 18 June, referring to the monetary policy corridor and the fact that banks were now borrowing rather than placing cash with RBI. That acts as a tightening, Subbarao said.

Market participants reckon there will therefore be no rate rise before 27 July, although a rise in fuel prices announced last week raises the odds somewhat for a move before then.

Subbarao also said the repo rate will be the operative rate for the next few weeks, indicating cash conditions will remain tight and the RBI would be doing more lending than accepting of cash in its monetary operations window.

Hitendra Dave, head of global markets at HSBC, said that even beyond July he expected a modest average liquidity surplus of around Rs200 billion a day.