RBI Likely To Keep Rates Steady; Focus On Managing Liquidity

The Reserve Bank of India (RBI) is likely to hold interest rates steady while trying to keep a tight leash on liquidity in a bid to ensure that inflation stays under control, said economists in a poll conducted by BloombergQuint.

Each of the 10 economists polled said that the central bank will leave the benchmark repo rate unchanged at the upcoming monetary policy review on Thursday, 6 April. This is in keeping with the central bank’s neutral stance on monetary policy. At its last review in February, the RBI surprised the markets by leaving rates unchanged and shifting its stance from accommodative to neutral as it feared that inflation may pick up during the course of this year.

Given that, economists see no rationale for a rate cut at this stage.

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Most economists feel that the rate cutting cycle is over as inflation will only rise from current levels.

Consumer price inflation stood at 3.65 percent in February, marginally higher than 3.17 percent in January. While retail inflation is currently below the RBI’s medium term target of 4 percent, the central bank expects a pick up in inflation to between 4-5 percent over the course of this fiscal. Wholesale inflation is already on the rise and soared to a 39-month high of 6.55 percent in February.

“We are of the view that the monetary policy will be on cruise control, i.e., the repurchase rate will be held steady at 6.25 percent at the April policy review and rest of the year. Beyond this, the next move is more likely to be a hike rather than a cut,” Radhika Rao, chief economist at DBS Bank, wrote in a note on Monday.

While half of the economists polled by BloombergQuint said it’s too early to take a call on whether there will be any rate cuts over the course of this financial year, 40 percent of the respondents said that they are not expecting any change in rates. One economist has pencilled in a 25 basis point (bps) cut in the repo rate later in the year.

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“There could be a 25 bps cut in the second half of the financial year if the situation eases but right now we are not expecting any change in the monetary policy stance except guidance on the future course of inflation and liquidity,” Saugata Bhattacharya, chief economist at Axis Bank, told BloombergQuint.

With no change in rates expected, the focus will be on the central bank’s guidance and on its stance on liquidity. Demonetisation, announced on 8 November, led to a surge in bank deposits. Even though withdrawal limits have been lifted, the banking system has been left with surplus liquidity.

In addition, strong dollar inflows into the equity and debt markets have left the central bank with a dilemma. While the RBI may want to mop up dollars to prevent excessive appreciation in the Rupee, doing so will lead to increased rupee liquidity in the market which could fan inflation.

The central bank is also low on government securities to offer banks in return for the money they park at the RBI’s reverse repo window. To overcome this, the RBI may introduce a liquidity tool called the Standing Deposit Facility (SDF) which will allow it to suck out liquidity without offering government bonds as collateral. By using such a facility, the RBI may be able to avoid hiking the Cash Reserve Ratio (CRR) which is seen as much as an interest rate signal as a liquidity signal.

“I think it’s too early to tell but the RBI will be looking to mop-up liquidity from the system. There’s some talk about the Standing Deposit Facility but the bank is unlikely to use the CRR since it’s a blunt tool,” said Shubhada Rao, chief economist at Yes Bank.

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Economists that BloombergQuint talked to were divided on the tools likely to be used for liquidity management. Some said the central bank will employ a mix of instruments as needed.

Abhishek Upadhyay, Economist – Fixed Income Strategy, ICICI Securities Primary DealershipAs of now, no measures are expected, but going forward they could do a combination of CRR, SDF, Reverse Repo and open market operations. At a later stage they might even choose to introduce creative measures, like increasing the CRR and paying interest on the excess CRR.

(Photo Courtesy: BloombergQuint)

Since the April policy review is the first of the financial year, the RBI will also detail its forecasts for growth and inflation. Most economists expect retail inflation to range between 4.5 percent and 5 percent for the financial year, with upside risks. The RBI is expected to say that it will try and bring inflation down to the 4 percent medium term target gradually.

With the impact of demonetisation having worn out, GDP growth is seen ranging between 7 percent and 7.5 percent with an upside bias.

(This article was originally published in BloombergQuint.)

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