Indian rupee to see mild pressure with RBI rate decision, liquidity measures in focus

The Indian rupee is poised to experience slight downward pressure at the start of trading on Wednesday, as market participants closely monitor the Reserve Bank of India's decision. Investors are keenly awaiting the central bank's announcement regarding the first interest rate hike in over three years and its strategy to manage surplus liquidity in the banking system. The rupee is anticipated to open within the range of 96.44-96.46 against the US dollar, following its settlement at 96.42 on Tuesday.

All attention will be on the Reserve Bank of India at 10:00 a.m. local time on Wednesday. According to a Reuters poll, 35 out of 61 economists believe the RBI will raise its repo rate by 25 basis points on Wednesday, while 26 anticipate no change. Swap markets suggest a 25-basis-point hike is already priced in, with some room for a larger 50-basis-point move.

A currency trader from a private-sector bank noted that a decision to keep rates unchanged would likely create immediate pressure on the rupee, pushing forward premiums higher. Conversely, a 50-basis-point rate hike could provide a boost, although the impact would likely be short-lived. A 25-basis-point hike would probably result in a more subdued market reaction, as per the trader.

Liquidity management is another critical aspect that market participants will focus on. The RBI has been employing various tools, such as variable-rate reverse repos, sell-buy foreign exchange swaps, and open-market bond sales, to absorb excess liquidity. Investors will be looking for indications on whether the central bank will persist in relying on temporary measures like variable rate reverse repo auctions or move towards more permanent solutions to address liquidity concerns.

While excess liquidity has been reduced through open market bond sales and foreign exchange operations (spot dollar selling and sell-buy swaps), substantial liquidity surplus remains, according to analysts at IDFC First Bank. The RBI faces the immediate challenge of maintaining the weighted average call rate in line with the repo rate, despite the continued presence of excess liquidity in the system.