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Home >News >India >RBI unwinding to not result in rate hikes in near-term

RBI unwinding to not result in rate hikes in near-term

RBI has said it will continue with accommodative stance for as long as required.

The rate corridor of 3.35-4% was losing its relevance with so much surplus liquidity, say experts

MUMBAI : The Reserve Bank of India (RBI) draining 2 trillion of liquidity on Friday shows that the regulator is setting into motion its unwinding sequence, but it does not indicate any turn in near-term rate cycle, say experts.

The Reserve Bank of India (RBI) draining 2 trillion of liquidity on Friday shows that the regulator is setting into motion its unwinding sequence, but it does not indicate any turn in near-term rate cycle, say experts.

The recent move by RBI comes after it announced it will resume normal liquidity operations aimed at correcting the short-term rates that fell lower than the reverse repo rate of 3.35%. The central bank has made it clear that there is a growing disconnect between certain segments of the financial markets and the real economy.

The recent move by RBI comes after it announced it will resume normal liquidity operations aimed at correcting the short-term rates that fell lower than the reverse repo rate of 3.35%. The central bank has made it clear that there is a growing disconnect between certain segments of the financial markets and the real economy.

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“Stretched valuations of financial assets pose risks to financial stability," RBI governor Shaktikanta Das said in his foreword to the Financial Stability Report. The government’s upcoming borrowing programme will also have a bearing on future rate actions.

“I think rates will not go up in a hurry as things are quite uncertain on the pandemic front. This situation is likely to last longer and it is not as if the vaccination is the end of all precautions. Risks might persist," said Ajay Manglunia, managing director and head of institutional fixed-income at JM Financial Products. The rate corridor of 3.35-4% was losing its relevance with surplus liquidity and money market rates going below the reverse repo rate, added Manglunia.

This gave a false impression that rates are likely to come down further, he said. “To contain liquidity and to ensure that asset prices remain at a realistic level, RBI decided to bring in the short-term variable reverse repo auction."

In a short-term reverse repo auction last week, the central bank set the cut off at 3.55%, 20 (bps) more than the reverse repo rate of 3.35%. This led to a rise in bond yields and experts said borrowing costs for companies are set to climb.

However, given that RBI has said it will continue with its accommodative stance for as long as required, the liquidity withdrawal may be gradual.

Meanwhile, after hovering above RBI’s flexible target of 2-6%, inflation, as measured by consumer price index, moderated to 4.59% in December on the back of falling food prices.

“Monetary policymakers might opt to look through the part-base effect driven, temporary moderation in consumer prices. Even with its announced withdrawal of liquidity, we do not see RBI signalling any policy tightening with falling inflation, and it may continue to remain on the sidelines, with little chance of a rate move in either direction in H12021," Rahul Bajoria, chief India economist at Barclays said in a note on 12 January.

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