What does the market want from RBI? Hint: It's not a rate cut

With growth and inflation seen as largely stable, the discussion centred on tools to address liquidity, which have remained under strain due to persistent RBI intervention in the foreign exchange market to curb excessive rupee volatility, strong credit growth, and advance tax outflows.

RBI’s Monetary Policy Committee will meet on 4-6 February, which will be its last such meeting of the current financial year. After delivering a 25 basis point rate cut last month, market participants said it is unlikely the rate-setting panel will cut rates again.

Market participants said there is little appetite for a rate cut at this stage. “Nobody was asking for a rate cut, and everybody was asking for liquidity only," an economist who attended the meeting said.

The market favoured a mix of instruments to ensure durable liquidity. Among the suggestions, the strongest consensus favoured the continued use of open market operations (OMOs) and dollar buy-sell swaps.

This has come as the market has become increasingly vocal about the need for durable liquidity infusions rather than reliance on short-term tools such as variable-rate repo operations. As of 21 January, liquidity in the banking system was in deficit of ₹60,000 crore.

An email sent to RBI seeking confirmation on the same did not elicit any response till press time.

Durable tools

OMOs were widely discussed, though with some caveats. While many participants argued for more bond purchases to inject rupee liquidity, others cautioned that banks’ ability to sell securities is constrained by liquidity coverage ratio (LCR) requirements. As a result, OMOs alone may have limited effectiveness if banks are unwilling or unable to part with their holdings.

One participant proposed that RBI consider publishing an indicative OMO calendar, possibly up to ₹5 trillion, for the next financial year to provide predictability.

Additional measures were also floated, with dollar funding stress cropping up in the discussions, and several participants flagged buy-sell swaps as an effective and flexible tool.

“We want more liquidity, and one of the primary tools which got discussed was buy-sell swaps because of dollar funding stress, and I think that's what the market evidently told them," a treasury official said.

Some suggested that RBI could announce another tranche of long-tenor swaps, potentially in the range of $5-10 billion, to reassure markets, particularly ahead of the March-end balance sheet tightening.

Other suggestions included longer-term variable-rate repos (VRRs), as short-duration VRRs were seen as offering only transient relief, and even a targeted long-term repo operation (TLTRO).

A few participants raised the possibility of a temporary 1% cut in the cash reserve ratio (CRR) if liquidity pressures persist, as such a cut would effectively infuse durable liquidity into the banking system. However, others said that with CRR already at 3%, RBI may want to preserve this tool for a more acute crisis.

In June 2025, the central bank cut CRR by 1%, phased it in four equal tranches till November, lowering it to 3% from 4%, and injected ₹2.5 trillion.

Borrowing burden

Concerns over the government’s borrowing programme also made the rounds, with combined central and state borrowing next year expected to reach around ₹30 trillion, underscoring the need for supportive liquidity management.

On the currency front, participants told RBI to avoid verbal intervention on the rupee, preferring actions over commentary. On Wednesday, the rupee hit a fresh record low of 91.7450 against the dollar as US President Donald Trump’s comments on taking over Greenland sparked fears of a trade war between the US and the European Union, prompting outflows from foreign portfolio investors.

The need for liquidity over rate cuts has come as, despite the 125 bps rate cut in 2025, yields on government bonds have only risen. Since last month, when RBI announced a 25 bps cut, the yield on the 10-year benchmark government bond has risen only 13-15 bps to 6.63%.

“From a rates perspective, we continue to think RBI is at the end of the rate-cutting cycle, and we forecast an extended hold in the repo rate at 5.25%. Capital outflows, FX intervention to cap INR weakness, coupled with elevated state government borrowing, are hindering transmission of RBI’s rate cuts to the broader interest rate structure. We foresee RBI injecting more INR liquidity through OMO purchases and USD/INR FX buy/sell swaps through 2026," MUFG Bank said in a note on 16 January.

Under OMO purchases, the central bank buys government bonds from banks and injects money into the banking system. Foreign exchange swaps, meanwhile, involve RBI purchasing dollars from banks against rupees and selling them back at a later date, thereby infusing liquidity into the system.

A variable-rate repo auction is a liquidity tool for the central bank, which it uses to inject short-term liquidity into the banking system. Banks borrow funds at a rate determined by the market through an auction process, rather than the fixed repo rate.