India’s central bank may tighten cash conditions, but CRR is unlikely to rise: traders

MUMBAI, Aug 9 (Reuters) – The Reserve Bank of India may seek to adjust domestic rupee liquidity to quell inflationary pressures, but will refrain from making permanent cash withdrawals, several traders and analysts said ahead of the review. monetary policy on Thursday.

The central bank is expected to keep policy rates stable, but it could change more hawkish given that inflation in July is likely to have exceeded its comfort band.

Reducing excess liquidity, which could fuel inflation, could be a way of signaling a tougher stance.

“Liquidity is one area where the RBI could surprise markets by being more aggressive than perceived,” said Ashutosh Tikekar, head of global markets – India at BNP Paribas.

The banking system’s liquidity surplus averaged about 2.5 trillion rupees ($30.19 billion) in August, up from 1.6 trillion rupees in July.

To durably reduce this, the RBI could raise the Cash Reserve Ratio (CRR) for banks from the current 4.5%.

However, Tikekar says the RBI is more likely to restart auctions of variable rate reverse repos (VRRR), which are used to extract cash for shorter periods of time.

However, the RBI’s latest VRRR auctions, including the last one on July 11, were met with reluctance by banks, which could be why the RBI is considering further steps.

Too drastic a move, however, could push up bond yields, which are already near four-month highs.

“Any major move would force rates one day above the repo rate and therefore negative for the near term,” said A Prasanna, head of research at ICICI Securities Primary Dealership.

“Much of the inflation surprise is due to vegetables alone and does not warrant any action by the RBI.”

The liquidity of the banking system increased as deposits increased after the withdrawal of the 2000 rupee notes and due to increased government spending and the RBI’s own purchases of dollars in the spot foreign exchange market.

This has brought the overnight interbank rate to an average of 6.38% in August, below the repo rate of 6.5%. The TREPS rate, which reflects the cost of money for non-banks, has hovered near 6.25%, the lower end of India’s interest rate band.

Madhavi Arora, economist at Emkay Global, said the RBI may avoid a blunt tool like a CRR increase, and might consider VRRR and a buy/sell currency swap.

In such a move, the central bank would sell dollars and soak up rupee liquidity while entering into a contract to reverse the transaction at a later date. ($1 = 82.8075 Indian rupees)

Reporting by Dharamraj Dhutia; Edited by Savio D’Souza

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