RBI unwinding to not result in rate hikes in near term: experts
Rates will not go up in a hurry as things are uncertain on the pandemic front, says an industry expert
The Reserve Bank of India (RBI) draining ₹2 lakh crore of liquidity on Friday shows that the central bank is setting into motion its unwinding sequence, but it does not indicate any turn in the nearterm rate cycle, experts said.
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 amply clear that there is a disconnect between certain segments of the financial markets and the real economy.
“Stretched valuations of financial assets pose risks to financial stability,” RBI governor Shaktikanta Das said in his foreword to the Financial Stability Report (FSR). 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 at JM Financial Products.
The rate corridor of 3.35-4% is losing its relevance with so much surplus liquidity and money market rates are going below the reverse repo rate, according to 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,” he said.
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 needed, liquidity withdrawal is expected to be gradual.
Meanwhile, after hovering above RBI’s flexible target of 2-6%, inflation as measured by the consumer price index (CPI) 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; it may remain on the sidelines, with little chance of a rate move in either direction in the first half of 2021,” Rahul Bajoria, chief India economist at Barclays.said in a note on January 12.
Others lauded RBI for not sucking out liquidity in an abrupt manner and rather going slow at a time when the economy is still not out of the woods.
“What the RBI has probably realised is that whatever quantitative easing in its own style it has done has either met or not met its purpose. The withdrawal is being done in a very smart way unlike what the Federal Reserve did... [creating] an upheaval in the international market,” said an economist on condition of anonymity.
He was referring to the US Federal Reserve’s announcement in 2013 that it will wind down its quantitative easing programme, a move that sent global markets in a tizzy and is popularly known as the “taper tantrum”.