It is widely expected that the central bank will restore the 100 bps corridor between the repo and the MSF rate on tuesday
In the last monetary policy review on September 20,, Reserve Bank of India (RBI) governor Raghuram Rajan -- which was his first policy announcement -- promised that he will take steps to bring the money market condition to normalcy where the repo rate becomes the operational rate once again.
He showed intention to keep his words as the central bank reduced the marginal standing facility rate further in October (after cutting in September policy review) and opened another liquidity window.
Now, it is widely expected that the central bank will restore the 100 bps corridor between the repo and the MSF rate in tomorrow's second quarter review of monetary policy.
The corridor could be restored by a few ways, but the street feels hiking repo rate by 25 bps to 7.75% and simultaneously cutting MSF rate by the same magnitude to 8.75% is the most probable outcome. The other option is to cut the MSF rate by 50 bps. The later is ruled out on the ground that headline inflation is picking up which may call for a hike in the key policy rate.
Earlier this year, on July 15, RBI unleashed an array of measures -- including hike in the MSF rate by 200 bps to 10.25 % and simultaneously capping bank borrowing from liquidity adjustment facility window. These moves were meant to make short term money dearer so that it is not used for speculative purposes which were exerting pressure on the exchange rate.
Once, these measures, along with steps to encourage inflows started showing favorable impact on the exchange rate, it was time to return to normalcy.
According to market participants, making liquidity available to banks to key for aligning short term rates to the repo rate. Merely restoring the repo-MSF corridor will not make the repo rate -- the key policy rate operational once again.
At the same time, the street is aware that Rajan will not allow any any sharp fall in interest rate to dilute hawkish stance on inflation.
“The restriction on LAF borrowing which is 0.5% of NDTL should continue. Instead RBI should increased the 0.25% of the NDTL borrowing under 7-14 term repo to 0.5% NDTL. When that is done the total liquidity that the banking system can get between LAF and 7-14 day repo is about Rs 80,000 crore. If liquidity deficit in the system is Rs 80,000 crore or below, then MSF ceases to be an operative rate. This will help to find a rate which is in between repo and MSF rate. The near-term short-term rates will find a level somewhere in between the repo and MSF corridor. This will also suit the current compulsions of monetary policy. This way the rate will not go to 7.5% which is too low considering the inflation. The rate will also not go to 9% because that will be too high given the growth constraints. The rate will be kept in between,” said Mohan Shenoi, president - group treasury and global markets, Kotak Mahindra Bank.
At present, banks can borrow 0.5% of their net demand and time liabilities from the LAF window as compared to no restriction of the pre-July 15 regime. The market is debating if the cap will be raised to 0.75% or 1% and few are expecting a complete removal of the ceiling.
“If RBI goes for a 1% of NDTL cap for repo borrowing, a large part of funding will be done through repo, and any requirement above that will go to MSF window. If not 1% then probably then can go for 0.75% of NDTL cap for banks. My suspicion is that RBI may go for 1% of NDTL cap because that is a reasonable signal that the exchange rate market is in control now. This will also be a signal to the financial market to go back to normal days. The decision to increase the repo rate by RBI will be based on their judgment of inflation-growth dynamics. If the cap of repo borrowing is increased from 0.50% of NDTL to either 0.75% or 1% of NDTL, then it will also help to narrow the gap between repo rate and short-term rates,” said Hitendra Dave, managing director, head of global markets, India at Hongkong and Shanghai Banking Corporation (HSBC).
He showed intention to keep his words as the central bank reduced the marginal standing facility rate further in October (after cutting in September policy review) and opened another liquidity window.
Now, it is widely expected that the central bank will restore the 100 bps corridor between the repo and the MSF rate in tomorrow's second quarter review of monetary policy.
The corridor could be restored by a few ways, but the street feels hiking repo rate by 25 bps to 7.75% and simultaneously cutting MSF rate by the same magnitude to 8.75% is the most probable outcome. The other option is to cut the MSF rate by 50 bps. The later is ruled out on the ground that headline inflation is picking up which may call for a hike in the key policy rate.
Earlier this year, on July 15, RBI unleashed an array of measures -- including hike in the MSF rate by 200 bps to 10.25 % and simultaneously capping bank borrowing from liquidity adjustment facility window. These moves were meant to make short term money dearer so that it is not used for speculative purposes which were exerting pressure on the exchange rate.
Once, these measures, along with steps to encourage inflows started showing favorable impact on the exchange rate, it was time to return to normalcy.
According to market participants, making liquidity available to banks to key for aligning short term rates to the repo rate. Merely restoring the repo-MSF corridor will not make the repo rate -- the key policy rate operational once again.
At the same time, the street is aware that Rajan will not allow any any sharp fall in interest rate to dilute hawkish stance on inflation.
“The restriction on LAF borrowing which is 0.5% of NDTL should continue. Instead RBI should increased the 0.25% of the NDTL borrowing under 7-14 term repo to 0.5% NDTL. When that is done the total liquidity that the banking system can get between LAF and 7-14 day repo is about Rs 80,000 crore. If liquidity deficit in the system is Rs 80,000 crore or below, then MSF ceases to be an operative rate. This will help to find a rate which is in between repo and MSF rate. The near-term short-term rates will find a level somewhere in between the repo and MSF corridor. This will also suit the current compulsions of monetary policy. This way the rate will not go to 7.5% which is too low considering the inflation. The rate will also not go to 9% because that will be too high given the growth constraints. The rate will be kept in between,” said Mohan Shenoi, president - group treasury and global markets, Kotak Mahindra Bank.
At present, banks can borrow 0.5% of their net demand and time liabilities from the LAF window as compared to no restriction of the pre-July 15 regime. The market is debating if the cap will be raised to 0.75% or 1% and few are expecting a complete removal of the ceiling.
“If RBI goes for a 1% of NDTL cap for repo borrowing, a large part of funding will be done through repo, and any requirement above that will go to MSF window. If not 1% then probably then can go for 0.75% of NDTL cap for banks. My suspicion is that RBI may go for 1% of NDTL cap because that is a reasonable signal that the exchange rate market is in control now. This will also be a signal to the financial market to go back to normal days. The decision to increase the repo rate by RBI will be based on their judgment of inflation-growth dynamics. If the cap of repo borrowing is increased from 0.50% of NDTL to either 0.75% or 1% of NDTL, then it will also help to narrow the gap between repo rate and short-term rates,” said Hitendra Dave, managing director, head of global markets, India at Hongkong and Shanghai Banking Corporation (HSBC).
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