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Home >Markets >Mark To Market >RBI gets a grip on short-term rates as market eyes further measures

RBI gets a grip on short-term rates as market eyes further measures

The RBI has got the yield curve flattened a bit by correcting the short-term rates

RBI said that liquidity operations would be restored to normalcy in a phased manner and took 2 trillion from banks at the first variable reverse repo auction on Friday, resulting in short-term money market rates rising by 15-20 bps

In the past fortnight, the Reserve Bank of India (RBI) did two things to restore the sanctity of the policy interest rate corridor. It said that liquidity operations would be restored to normalcy in a phased manner. It took 2 trillion from banks at the first variable reverse repo auction on Friday at a cutoff rate of 20 basis points above the reverse repo rate of 3.35%. One basis point is one-hundredth of a percentage point.

In the past fortnight, the Reserve Bank of India (RBI) did two things to restore the sanctity of the policy interest rate corridor. It said that liquidity operations would be restored to normalcy in a phased manner. It took 2 trillion from banks at the first variable reverse repo auction on Friday at a cutoff rate of 20 basis points above the reverse repo rate of 3.35%. One basis point is one-hundredth of a percentage point.

Both actions resulted in short-term money market rates rising by 15-20 bps, and the expectations are that cutoffs at the Treasury bill yields during Wednesday’s auction will be higher than the previous ones.

Both actions resulted in short-term money market rates rising by 15-20 bps, and the expectations are that cutoffs at the Treasury bill yields during Wednesday’s auction will be higher than the previous ones.

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On Tuesday, the weighted average call money rate rose to 3.45% to get wedged in the 3.35-4.0% policy rate corridor.

“It is clear that what the RBI wanted to do is to re-establish the monetary corridor. The cutoff at the reverse repo auction shows they are serious about the sanctity of the corridor," said R. Sivakumar, head of fixed income at Axis Mutual Fund.

To be sure, the move to revert back to normal liquidity operations is just a tactical one to manage short-term liquidity excesses. The rise at the short-term has just corrected a distortion in the wake of the persistent surplus liquidity.

Recall that short-term rates had persisted below the reverse repo rate for several months in 2020 before the RBI signalled a rollback of pandemic-related liquidity measures this year.

Nevertheless, the bond market has taken note of it because of which yields beyond the short-term have also inched up marginally. To be sure, bond yields are still far lower compared with their year-ago levels.

Sivakumar does not expect a further rise in rates unless the central bank increases the frequency of daily operations and continues to signal an increase in interest rates through higher cutoffs at such auctions.

For now, the persistent surplus liquidity may maintain the pressure on money market rates, preventing a further rise. The surplus is mainly due to the RBI’s forex interventions and so is durable in nature. To erode this surplus, the RBI will have to take other measures beyond daily liquidity operations.

Here, it gets tricky for the central bank. Any indication or measure of reducing liquidity significantly may drive up yields across the curve, endangering the government’s market borrowing for the rest of the year.

“The balance that they have to maintain is a very fine one because they do not want to drive up long-term yields in a way that the economic recovery gets hit. But at the same time, the RBI cannot allow short-term rates to be in a different stratosphere," said an economist requesting anonymity.

The RBI has got the yield curve flattened a bit by correcting the short-term rates. Beyond this tactical liquidity management, the central bank may need to tread carefully.

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