There is no doubt that the Reserve Bank of India (RBI) has handled the coronavirus situation very well. It kept the currency volatility in check and yields in a tight range despite global inflationary pressure to support the government’s borrowing programme.
But the central bank faces a dilemma on prioritising issues as excess liquidity could be the reason for rising inflation, which is already getting out of its hands. Rising inflationary pressure demands higher yields, which the RBI seems not in favour to provide, in fact, it is ready to devolve their auction.
In the RBI policy, due on August 6, the central bank is unlikely to rock the boat. It is expected to keep the repo rate unchanged at 4 percent and the reverse repo rate at 3.35 percent. The unanimous view is that RBI will reiterate accommodative stance but it could tweak the growth forecast lower and signal a risk of rising inflation.
The recent inflation figure has been a headwind for the central bank as the consumer price index has stayed above the 4 percent midpoint target for 21 consecutive months and above the 6 percent band for more than half of that period.
Apart from growth and keeping inflation in check, the RBI’s focus will be on the ballooning liquidity in the banking system, especially the stance on variable rate reverse repo operations.
It’s been six months that the RBI has been conducting 14-day variable rate reverse repo operations in tranches of Rs 2 lakh crore to curb the excess liquidity in the banking system.
Currently, liquidity in the banking system and funds with the government have risen to Rs 10 lakh crore. The redemption of treasury bills worth Rs 1.7 lakh crore is also maturing this July-September quarter, which will be added to it.
The central bank is committed to purchasing government bonds worth Rs 1.2 lakh crore this quarter under G-SAP 2.0 to infuse durable liquidity in the system.
During the G-SAP 1.0 plan, the RBI had purchased bonds worth Rs 1 lakh crore in FY22.
Also read: Inflation rising, MPC will have to tread a cautious path, says Upasna Bhardwaj of Kotak Mahindra Bank
CR Forex Research team believes that it is important for the RBI to keep sufficient liquidity in the market but at the same time, it becomes equally important to absorb unnecessary or excess liquidity.
In the bond market, the RBI was seen devolving a larger portion of the recently introduced 10-year paper maturing in 2031 at 6.1 percent, as investors were chasing yield above 6.2 percent against the central
bank’s cut-off 6.15 percent.
The rising global inflationary pressure may hint that the RBI may not be able to sell its securities at a lower yield (means higher prices) in the near future. To keep investor’s interests intact, the central bank has to come up with a rescue plan of special OMO, where it purchases and sells government securities simultaneously.
In short, RBI buys a long-term maturity bond and sells short-term papers. In a recent meeting between the RBI and the bond market players, the central bank received the feedback that it has to prepare the market ahead of any twist in the voluntary retention route (VRR) size or tenure.
Being the government’s debt manager, the RBI has to strike a balance. Its key result areas probably include controlling liquidity portion well, check inflationary pressure, conduct auctions near investor’s expectations of yield, keep borrowing costs low to support the government and keep policy growth-oriented to support those sectors which affected the most.
In the currency market, the RBI is running an extra mile to keep volatility subdued and at the same time steadily increase its forex reserves by intervening in the spot market. If levels are not favourable, then it is likely that it gets the delivery of the forwards and increases its dollar bucket.
The impact of RBI’s policy on the rupee is likely to remain low as it is expected to keep rates unchanged. However, any change turn in the bank’s liquidity stance could impact the local currency.
We broadly expect the USD-INR pair to remain well supported near 74.10-20 levels and could bounce again towards 74.80-90 before flying on its way towards 75.30-75.50 levels on any other big trigger.
(The author is Managing Director and Founder of CR Forex)Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.