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Informist, Thursday, Jan. 16, 2025

 

By Aaryan Khanna and Siddhi Chauhan

 

NEW DELHI/MUMBAI – The Reserve Bank of India's daily variable rate repo auctions are likely to keep overnight money market rates close to the policy repo rate of 6.50%, bringing down yields on the shortest tenure debt instruments. While the measure will iron out some of the distortions in money market rates, it does not provide the medium-term assurance that the market needs, bankers and analysts said.

 

On Wednesday, the central bank said it would conduct overnight variable rate repo auctions on all working days "until further notice", with Friday's auctions maturing on Monday. It would tailor the amounts based on the liquidity needs of the banking system, with the amounts being announced in press releases. The auctions will allow participation from standalone primary dealers.

 

Balance sheet managers were the happiest after the move, with the central bank's promise of overnight cash infusion making asset-liability management easier. Coming a week after the overnight benchmark Mumbai Interbank Offer Rate spiked to over 7%, the measure is expected to ensure stable funding costs for banks on a day-to-day basis.

 

Moreover, the tool delivers on the "neutral" stance the RBI's Monetary Policy Committee adopted in October, dealers said. At the time, market participants had expected that the RBI shedding its stance of withdrawal of accommodation meant it would constantly provide enough liquidity to keep interbank borrowing costs near the repo rate. The last two months of tight liquidity and the RBI's non-committal liquidity management ended up signalling a lack of intent to ease monetary policy anytime soon. The central bank's latest initiative to curb funding costs is, therefore, a heartening sign.

 

"The entire market will welcome this move by the RBI," said Ajay Massand, head of the Balance Sheet Management Group at YES Bank. "It will keep overnight money market rates anchored nearest to the repo rate on a daily basis, reducing the variance in funding costs that we have seen in the recent past."

 

The announcement of what is essentially a daily variable rate repo window--at least until further notice--fulfils some demands made by treasury heads of banks and primary dealers at a meeting with RBI officials last week. Informist had reported on Friday, quoting market sources, that the central bank was asked to ease the persistent cash crunch in the banking system. The RBI's net injected liquidity--a proxy for the systemic liquidity deficit--has averaged over INR 1.1 trillion since the last monetary policy meeting on Dec. 6.

 

DURABLE LIQUIDITY PANGS

One problem that the daily repo auctions do not solve is that durable liquidity remains at its lowest since April 2023, according to RBI data as on Dec. 27. Some analysts calculate that durable liquidity--which includes the government's cash pile in addition to banking system liquidity--has fallen into negative territory for the first time since at least 2020.

 

While treasury desks were happy with the immediate move downwards in overnight rates, bankers said the cushion may extend only to the money market rather than the broader economy. The pace of lending activity, which has slowed in recent months and is reflected in a slowing economy, would not be boosted by the addition of fleeting liquidity. Moreover, the overnight variable rate repos do not even offset the RBI's drain of durable liquidity through its daily dollar sales, as part of its measures to keep a sliding rupee in check, dealers said.

 

To be sure, the announcement was seen as a shift in the RBI's liquidity management to a more proactive measure, unlike the earlier approach which entailed responding to tight liquidity. Despite being disappointed over the past month by the lack of durable liquidity infusion, some traders were hopeful that open market operations, long-term dollar-rupee buy/sell swaps, or a cash reserve ratio cut were imminent. In the meantime, traders expected the RBI to continue with its main 14-day repo and reverse repo tenders, part of its liquidity management framework.

 

"Overnight repos are a good start as it fulfils the major objective of the RBI to keep the overnight rates near 6.50%," Upasna Bhardwaj, chief economist at Kotak Mahindra Bank, said. "The RBI will have to use various durable measures, among which we prefer OMOs, over the next few months to manage the expected liquidity drain. If the central bank does not take further steps, I don't think short-term rates have much room to fall."

 

MARKET IMPACT

As the outlook on money market rates brightened, overnight indexed swaps and the government's short-term borrowing costs were the first to fall. Swaps maturing in less than a year fell by 6-7 basis points Thursday. Meanwhile, the 91-day Treasury bill traded at 6.56% in the secondary market, a day after being picked up at auction at 6.60%. Dollar-rupee forward premiums eased sharply after the measure, with the benchmark one-year dollar/rupee forward at 2.36% on an annualised basis, the lowest level since Dec. 30.

 

Traders said the RBI joining the government in giving immediate liquidity support would lead to short-term yields falling more than those of longer tenures, provided no durable liquidity measures were announced. Helped by other positives, benchmark government bonds in five and seven years also fell by 7 bps each, against a fall of 6 bps in the 10-year gilt. The spread between short-term bonds and the 10-year yield increased early in the day, before hopes of RBI OMO buys again took over the gilt market.

 

"With the introduction of the daily variable rate repo, the central bank seems to be paving the way for a rate cut, if not in February, then in April," said Vijay Sharma, senior executive vice-president at PNB Gilts. "But after normalising liquidity this way, the hopes for an OMO had come down. It is only later in the day, with reports that durable measures are coming, that the rally in the 10-year got fresh legs."

 

Meanwhile, the rates on three-month certificates of deposits fell by only 2-3 bps, while across the curve, the fall was limited to 3-5 bps, dealers said. Rates for commercial paper issued by manufacturing companies fell by 5 bps across the curve. Similar was the fall on CP issued by non-banking finance companies across tenures, dealers said. With investors not used to overnight rates sustaining at the repo for an extended period over the past year, traders said core liquidity measures need to be taken to see a sharp fall. 

 

"To the extent that the market takes this as a strong signal that the RBI has swung into action and reads this (as we do) as the precursor to imminent steps on adequate permanent liquidity measures, some relief may start to percolate to the front end of the non-SLR (statutory liquidity ratio) curve as well (bank CDs and 1–2 year corporate bonds)," Suyash Choudhary, fixed income head at Bandhan Asset Management Co., said in a note. "...in our assessment, what matters more for rates falling at this juncture is infusion of permanent liquidity rather than a rate cut."  End

 

Edited by Rajeev Pai

 

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