RBI likely to keep rates unchanged

MONETARY POLICY REVIEW Focus will be on squeezing excess liquidity from the banking system, say economists

THE SURGE IN CASH DEPOSITS FOLLOWING DEMONETISATION HAS RESULTED IN LIQUIDITY RISING TO Rs 4 L CR IN MARCH FROM Rs 2 L CR IN JANUARY

The Reserve Bank of India (RBI) will focus on squeezing excess liquidity from the banking system in its monetary policy meeting on April 5-6 while keeping policy rates unchanged and retaining its neutral stance, according to a Mint survey.

The surge in cash deposits following demonetisation resulted in liquidity rising to Rs 4 lakh crore in March from Rs 2 lakh crore in January. Announcing the February 8 policy, RBI said surplus liquidity should decline with progressive re-monetisation, but the abundant liquidity with banks is now expected to persist into the early months of fiscal 2017-18.

“We don’t expect any change in the monetary policy stance as growth-inflation dynamics haven’t changed much since February. The main focus is on what the RBI does with the excess liquidity in the system and what tool it uses to make system liquidity more consistent with its neutral monetary policy stance,” said Sonal Varma, chief economist, Nomura Holdings.

A majority of economists expect RBI to introduce a Standing Deposit Facility (SDF) framework to help drain surplus cash from the system without the need for any collateral. This facility, which was first introduced in the Urijit Patel committee report, allows banks to park their excess liquidity with RBI with the exception that it does not have to provide any collateral in exchange.

Economists believe that SDF is a better option compared to a permanent liquidity measure like a hike in the cash reserve ratio (CRR), or portion of deposits that banks have to maintain with RBI.

“We do not expect the central bank to increase the CRR from the current level of 4% to absorb the surplus liquidity, as that would deter banks from reducing lending rates, delaying the transmission of past monetary easing,” said Naresh Takkar, MD and group CEO, ICRA Ltd.

“In contrast, open market sales of the RBI’s holdings of government securities that stood at Rs 7.5 lakh crore on March 10, 2017, could be utilised to absorb the liquidity surplus. Such sales of bonds would also help to absorb the rupee liquidity generated vide any purchases of foreign exchange, simultaneously shoring up the country’s forex reserves and slowing the sharp appreciation of the rupee.”

Matters have become more complicated for RBI because of the rupee strengthening by 5.2% against the US currency since 23 January. A strong rupee will force the central bank to buy dollars, adding more rupee liquidity to an already awash banking system, stoking inflation.

Eleven out of 13 economists surveyed by Mint expect the central bank to maintain its 4% inflation target by March 2018 in the first meeting of the monetary policy committee in the current fiscal year, leaving little room for a cut in policy rates this year. In its February policy, RBI projected retail inflation at 4-4.5% in the first half of the current fiscal and 4.5-5% in the second half.

“While there is no scope for any rate cut in the upcoming monetary policy, a fragile domestic recovery combined with the tailwinds coming from global economy may prompt the RBI at least to revisit its stance of neutrality,” said Rupa Nitsure, group chief economist, L&T Finance.

The Hindustan Times New Delhi, 03rd April 2017

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