Bond market expects RBI to go slow on liquidity normalisation
MUMBAI: The Union government’s massive borrowing plans have given hope to the bond market that the Reserve Bank of India (RBI) may go slow on its liquidity normalisation plans. The central bank’s monetary policy committee, which began meeting on February 3, will announce its outcome on Friday.
Last month, the central bank had said it will begin to drain out excess liquidity and bring overnight lending rates closer to the reverse repo rate. Shortterm rates inched up after RBI on January 15 conducted a ₹2 lakh crore 14-day reverse repo auction, in the first step towards normalization.
However, expectations have reversed after finance minister Nirmala Sitharaman in her budget speech said the government will borrow ₹12 lakh crore next fiscal year, in addition to an extra ₹80,000 crore this fiscal year. The bond market now expects RBI to continue providing enough system-level liquidity to support government borrowing and start normalizing its ultra-loose liquidity plan only by the third quarter of next fiscal.
After the budget, the market is currently at the crossroads, said Harihar Krishnamurthy, treasury head, First Rand Bank.
“It is only good that monetary policy also complements the fiscal policy and makes sure the fiscal policy achieves what it has set out to achieve. If that’s the objective, the reverse repo window is shut down and the market spends the ₹2 lakh crore and RBI continues to buy dollars on spot, that pushes the liquidity in the marketplace and pauses the normalization of interest rate. On the other hand, the monetary policy committee could be facing a dilemma that the economy is doing a double-digit growth rate and real interest rates are negative and at what stage they commence normalization. At the policy level, they must be at the crossroads,” Krishnamurthy said.
The market is expecting RBI to do a series of open market operations by purchasing old government securities to inject liquidity into the system, so that banks can support the borrowing programme. However, there are concerns whether the market will be able to absorb such a huge borrowing considering that deposit growth is likely to slow down given the rising inflation.
“It will be difficult for the market to absorb outsized government borrowings for the second consecutive year, especially when interest rates have likely bottomed out and liquidity is normalizing,” said Pranjul Bhandari, chief India economist, HSBC.