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Informist, Wednesday, Jun. 25, 2025

NEW DELHI – The Reserve Bank of India's decision to conduct a variable rate reverse repo auction this week is confusing and suggests a higher bar for future rate cuts, Nomura said in a report Wednesday. Rates strategist Nathan Sribalasundaram held on to a receive recommendation on the two-year non-deliverable overnight indexed swap but reduced the conviction on his long position on the 6.75%, 2029 gilt.

"On balance, we find this confusing, especially after the large 50bp (basis point) cut, which was to front load policy easing," according to the report. "Additionally, the implicit market signal is that the bar for further cuts is even higher now."

The RBI's Monetary Policy Committee cut the policy repo rate by 50 basis points to 5.50% earlier in June but changed its policy stance to "neutral" from "accommodative". Members of the rate-setting panel said in the minutes of the meeting that they had cut rates by a larger quantum than expected to enhance transmission to credit and deposit rates. The weighted average call rate, the operating target of monetary policy, has been near 5.30% since the panel's decision on account of surplus liquidity in the banking system.

The central bank Tuesday announced a seven-day, INR 1.00-trillion VRRR auction for Friday, the first time since November that it will use the tool to drain short-term liquidity. The base case for Nomura is that the RBI holds off on further VRRR auctions in the near term as it focuses on transmitting the 100 bps of rate cuts since February through surplus liquidity and low volatility in funding rates. Nomura said in its report that the weighted average call rate is likely to settle at 5.30-5.35% after the first auction, following which it will be important to see whether the central bank conducts further VRRR auctions.

The RBI may be approaching liquidity management with the literal policy objective of keeping the operative rate close to the repo rate, Nomura said. This approach is academic and does not factor in either market fluctuations or the implicit signal it sends, according to Nomura's report. Earlier this week, Nomura's economists said they still expect a further 50 bps of cuts in the repo rate to 5.00% in the current cycle.

"Additionally, a review of the liquidity management framework is ongoing, and there have been many comments and suggestions that the RBI should move the operative rate to a secured rate (eg TREPS), which has been trading below the SDF (standing deposit facility) rate," Sribalasundaram said, explaining the announcement. The weighted average tri-party repo rate has often been below the lower end of the policy corridor, the SDF rate of 5.25%, since late May.

The rates strategist expects surplus liquidity in the banking system to average around INR 2.50 trillion in July. With nearly half of it parked under the VRRR window at near the repo rate of 5.50%, money market rates would rise. Month-end spending by the government may lead to a temporary increase in the surplus to around INR 4.00 trillion, according to Nomura's report, which would be quickly withdrawn through auctions and tax outflows. The net liquidity absorbed by the RBI--a proxy for the banking system liquidity surplus--was INR 2.59 trillion Tuesday, according to latest data.

The overnight Mumbai Interbank Offered Rate--the floating leg of the OIS contract--is seen rising to 5.35-5.40%, Nomura said. The MIBOR rate had been fixed at 5.30% between Jun. 17 and Tuesday, and inched up to 5.33% Wednesday. The rise in the fixing and lower likelihood of rate cuts pose risks to Sribalasundaram's call of the two-year non-deliverable OIS rate falling to 5.25%, according to the report. Positive bond technicals for buying the five-year gilt remain, through continuing gilt switches, low credit growth, and low regulatory holdings.

"However, near-term catalysts are limited owing to this VRRR announcement, so we have decided to reduce the position (latest 6.02%) back to 3/5. Because of the tightness of bond-swaps (5-year: 32bps) our preference is to add risk in the NDOIS market at better levels," Sribalasundaram said.  End

Reported by Aaryan Khanna

Edited by Rajeev Pai

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