Focus on two-way liquidity operations as volatility rises

The levels of liquidity in the system had led the markets to believe that the move to a neutral policy stance was imminent.

Focus on two-way liquidity operations as volatility rises
The 50-basis point hike in the repo rate was also higher than the estimates of some market players.

The Reserve Bank of India (RBI) on Friday said it will focus on conducting two-way liquidity operations in keeping with the continuously evolving developments in the banking system liquidity.

The monetary policy committee (MPC), in its August policy meeting, voted to continue with the withdrawal of accommodation, contrary to expectations among some bond market participants that the policy stance would change to neutral.

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The 50-basis point hike in the repo rate was also higher than the estimates of some market players, which resulted in the yield on the 10-year benchmark government security rising to 7.3% after the policy announcement from the previous day’s close of 7.157%. RBI governor Shaktikanta Das said the introduction of the standing deposit facility (SDF) in April 2022, which raised the floor of the liquidity adjustment facility (LAF) corridor by 40 bps, along with the repo rate hikes of May and June, has effectively resulted in the withdrawal of accommodation by 130 bps. Surplus liquidity in the banking system fell to `3.8 trillion during June-July from `6.7 trillion during April-May.

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“Going forward, and as indicated in my February 2022 statement, the RBI will remain vigilant on the liquidity front and conduct two-way fine-tuning operations as and when warranted — both variable rate repo (VRR) and variable rate reverse repo (VRRR) operations of different tenors— depending on the evolving liquidity and financial conditions,” Das said.

He attributed the sharp moderation in surplus liquidity from July 20 to tax and capital outflows, though some market players believe that the RBI’s currency market interventions and poor government spending may also have played a part.

Rahul Bajoria, MD & chief India economist, Barclays, said banking system liquidity has fallen since April, driven by capital outflows, an increase in government cash balances and currency withdrawals by the public. “Given the subdued pace of spending by the government, we think liquidity tightness could continue in the near term,” Bajoria said.

The levels of liquidity in the system had led the markets to believe that the move to a neutral policy stance was imminent. Suyash Choudhary, head – fixed income, IDFC Asset Management Company (AMC), said RBI deputy governor Michael Patra’s comments in June had led people to believe that with the stance turning neutral, the RBI may make efforts to anchor the overnight rate towards repo rather than the SDF.

“Thus we were expecting an effective rate hike higher than what the movement in repo rate would be. However, what has turned out is somewhat different. Stance has continued as withdrawal of accommodation, thereby de-linking it completely from the level of pre-pandemic repo rate,” Choudhary said.

According to Choudhary, the market was disappointed by the complete lack of guidance in the August policy statement and post-policy interaction. “But so long as the progression of global macro data remains consistent with what we are witnessing today, one shouldn’t need too much guidance to begin forming a more benign view on where this cycle peaks out,” he added.

One clear takeaway for the market was that the rate-hiking cycle is far from over. Lakshmi Iyer, chief investment officer (debt) & head – products, Kotak Mahindra AMC, said, “We see this as a ‘no dovish’ undertone policy contrary to markets expecting a dovish stance. Bond markets would now focus on incremental G-sec supply and take cues from global bond yields going forward.”

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