India bond traders see RBI stepping up liquidity withdrawal as it paves way for rate hikes
MUMBAI: Indian government bond traders are expecting the central bank to absorb a jump in surplus liquidity in the banking system using longer-lasting tools as it prepares to tighten monetary policy amid rising inflation risks. Liquidity in the banking system has surged as Indian banks raised foreign currency non-resident (FCNR) deposits, then swapped them with the Reserve Bank of India under a…
Indian government bond traders anticipate the Reserve Bank of India (RBI) will intensify liquidity withdrawal measures to prepare for potential rate hikes, as banking system surplus liquidity escalates. The banking sector has witnessed a $65 billion influx into the banking system through foreign currency non-resident (FCNR) deposits, which were subsequently swapped with the RBI under a temporary arrangement to bolster the rupee.
As of August 21, India's banking-system liquidity surplus averaged more than 3.4 trillion rupees ($36 billion), and this figure is projected to rise further upon the completion of the final non-resident inflow swap before the window closes this month.
Moreover, bond redemptions are expected to inject more than 630 billion rupees into the banking system within the upcoming two weeks, which could elevate surplus liquidity above 5 trillion rupees in September. To cope with the burgeoning surplus, the RBI may implement a diverse set of liquidity drainage tools for extended durations, according to six treasury officials.
Abhishek Upadhyay, co-head of research at ICICI Securities Primary Dealership, highlighted the likelihood of the RBI resorting to a wider array of tools to avert overnight rates from reaching the lower bound. Upadhyay suggested that the RBI might employ three-month variable rate reverse repo auctions with an early-reversal option, coupled with foreign-exchange sell/buy forward swaps of comparable maturities.
Additionally, the RBI could augment banks' incremental cash reserve ratio (CRR), necessitating banks to reserve a greater share of fresh deposits as reserves. Currently, the CRR requirement does not apply to FCNR deposits raised under the special window. Tighter monetary policy conditions typically coincide with higher policy interest rates, prompting banks to pass on such tightening to borrowers.
Consequently, the RBI has been conducting short-term VRRR auctions to manage the surplus liquidity resulting from the FCNR deposits. Alok Singh, head of treasury at CSB Bank, estimates a greater-than-50% probability of implementing longer-duration VRRRs, although an interim CRR increase is more probable if inflation surges to 6%.
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