Despite liquidity concerns addressed by RBI, economists bet on another rate cut in April policy to aid growth

RBI

Even though the Reserve Bank of India (RBI) has been addressing liquidity concerns since the last few months by funnelling cash into the banking system through various instruments, economists are factoring in another rate cut in the next monetary policy announcement in April.

This is because, say experts, whatever rate cut has happened is not enough to lower borrowing costs, stimulate private investment and boost consumption. Also, between now and April's monetary policy, most economists are expecting Consumer Price Index (CPI) inflation to ease further even as the rise in food prices slows, which creates room for dropping the policy rate further.

“With FY25 trend growth expected to moderate to around 6 percent from a revised 9 percent in FY24, food disinflation setting in, and successive measures to ease macroprudential restrictions, policymakers have room to maintain a dovish stance. We expect a rate cut in April, with a likely shift towards an accommodative policy stance,” Radhika Rao, executive director and senior economist at DBS Bank said after the GDP growth numbers were released in end-February.

RBI monetary policy committee (MPC) external member Ram Singh said demand expectations are important for investment decisions, and that the high interest rates have raised the risk premium assigned to capital investments. “This seems to be a leading factor behind the noticeable slowdown in the flow of funds to the commercial sector,” he added.

The central bank in its February monetary policy reduced the repo rate by 25 basis points (bps), the first cut in almost five years, to give a boost to a slowing economy.

This was done after holding the repo rate at 6.5 percent for 11 consecutive policies. The RBI  increased the repo rate by 250 basis points from May 2022 to February 2023 to 6.5 percent and held it at that level to keep a check on inflation rate and bring it to the medium-term target of 4 percent.

The Indian economy recovered in the December quarter, growing at 6.2 percent after sinking to a seven-quarter low of 5.6 percent in the July-September period, according to the data released on February 28.

The third-quarter number was a tad below the MC poll median of 6.3 percent but helped retain the full-year forecast of 6.5 percent, according to second advance estimates.

Apart from this, economists were also predicting the huge additional liquidity support by the RBI to combat tight liquidity. Typically, liquidity in the banking system in March dries up and falls to a higher deficit due to advance tax and goods and services tax (GST) outflows.

“We expect further infusion by March 2025 to make core liquidity a mild positive. For system liquidity there will be a drain on excise tax payment, advance tax payment and GST payment due date,” said Gaura Sengupta, economist at IDFC First Bank.

To address this, the central bank on March 5 announced additionally liquidity infusion through two Open Market Operations (OMO) purchases of Rs 50,000 each and a $10 billion dollar-rupee buy/sell swap auction.

All the auctions will take place just before or after the outflows from the banking system on account of tax. Advance tax outflows take place on March 15 and before and after that, i.e., March 12 and March 18. The RBI has decided to conduct Rs 50,000 crore of purchases at each OMO.

Similarly, GST outflows take place on 20th of every month, so the central bank will hold the buy/sell swap auction on March 24.

Apart from the tax outflows, liquidity in the banking system has also been under stress in the last few months due to slower government spending, interventions in the foreign exchange market by the RBI, and heavy selling by foreign portfolio investors in Indian equities.

To support liquidity in the banking system, the RBI has since late 2024 infused around Rs 3 lakh crore worth of durable liquidity, tapping a combination of VRR or variable rate repo auctions, swaps and OMOs.

As per data collected from the RBI website, it has infused Rs 51.28 lakh crore through daily VRR auction, normal VRR auctions and OMO purchases. On top of this, the central bank infused around Rs 1.30 lakh crore through the dollar-rupee swap auction.

The total liquidity infusion was in gross terms, most of which has been reversed back to the RBI due to maturity on a later date.

The funds infusion was in line with RBI governor Sanjay Malhotra’s comments during the February monetary policy announcement that the central bank was committed to provide sufficient system liquidity.

“We have taken a number of steps in this regard. We will continue to monitor the evolving liquidity and financial market conditions and proactively take appropriate measures to ensure orderly liquidity conditions,” Malhotra added.