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State Bank of India (SBI) Research Report stated that the Reserve Bank of India (RBI) is likely to increase the reverse repo rate by 20 bps outside MPC. The report titled  ‘20 bps hike in reverse repo rate outside MPC’ is authored by Dr Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India. “Given all this, we believe the time is now appropriate to go for a 20 bps hike on reverse repo rate, but outside the MPC meeting as enshrined in the RBI act that clearly lays down that reverse repo is more of liquidity management. A hike in the reverse repo is also required as a larger corridor has resulted in rate volatility." the report said.

“For example, the call money rate showed extreme volatility in the month of Jan’22. The gap between High and Low rates during Jan’22 was as high as 79 bps. Even at three instances, the call money rate touched the 4.0% mark also. The reason for this enormous volatility in call money rate is due to wide LAF corridor (currently at 65 bps). Further, the auctioned variable reverse repo rate stands at3.99%, just below the repo rate," the report added.

RBI is likely to maintain the status quo on key policy rates in its next bi-monthly economic policy, which will be the first after the presentation of the Union Budget for 2022-23. Experts, however, are of the opinion that RBI's MPC may change the policy stance from 'accommodative' to 'neutral' and tinker with the reverse-repo rate as part of the liquidity normalisation process.

Highlights from the report:

  • The large size of the FY23 market borrowings at 14.3 lakh crores and with no progress on the inclusion of the Indian debt market in the global bond indices yet begs the question of whether the RBI might have to delay the liquidity normalisation in an effort to support the large borrowings programme. While the budget needs to be complimented for fiscal transparency as it is on course to align all off-balance PSU borrowings ( 7.7% of GDP) and fiscal deficit (6.4%) possibly by FY24, this would clearly result in a trade-off between liquidity normalisation or rate adjustments.
  • The larger question is the blurring of debt management and liquidity management operations of RBI. This again raises the question of whether debt management functions of the RBI needs to be separated from monetary management.
  • Based on the ownership pattern of Government of India dated securities as on Sep’21 and given the total net borrowings of Centre at 11.2 lakh crore, we believe demand of securities from banks has to be around 4.2 lakh crore (considering NDTL increase of 10% and 27% of SLR). The insurance sector could subscribe to 2.7 lakh crore. This implies RBI would have to still ensure the demand of at least 2.0 lakh crore through OMO purchases. This leaves the question of liquidity normalisation complicated. It is an irony that outstanding Dated Government Securities (as on January’22-end), aggregating 80.8 trillion and due for redemption till 2061, have a handful of formidable players like Banks and Insurance companies who together account for ~62% ownership among themselves / 50 trillion though overall share of Banks has dwindled by ~10% in the last decade (from 47.25% in March 2010).
  • Given that Banks and Insurance companies largely carry the burden of managing the market of G-secs, the next question is of redemption patterns. In the current fiscal (YTD), out of total G-Sec issuance of 8.27 Tn, bonds due for repayment in 0-5 and 5-10 years bucket constituted 28.4% and 24% of total value respectively, implying ~48% of the amount raised were through papers having maturities in excess of 10 years. Banks prefer papers of 10 years and below and insurance companies of larger than 15 years. RBI may have to change the composition of outstanding as well as fresh/to-be-issued papers in FY23 with medium duration offerings / 10 years and below elbowing longer tenor papers to balance redemption pressures going forward. It is to be noted that satiating the market's craving for liquidity annihilation of late through siding with a longer period of 28 -days VRRR are only measures of exigencies and not permanent tools of liquidity adjustment.

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