RBI’s cash flow crunch to trigger a rally in money market rates

India’s money market policy rates and short-term debt yields are set to rise after the central bank takes its first small step to reverse emergency pandemic measures.

the Reserve Bank of India will aim to drain 2 trillion rupees ($ 27.3 billion) of bank funds through a 14-day reverse repurchase transaction on January 15, the central bank said in a statement Friday evening. This is the first step in a gradual normalization of central bank liquidity operations, he said.

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There has been a growing consensus among traders that the RBI will need to start draining excess cash as the surge in liquidity has caused money market rates to fall below the interest rate corridor of the United States. central bank and distort asset prices. Quantum Asset Management Ltd. and IDFC Asset Management Ltd. were among those who predict that short rates will rise faster than the long end as a result, even though no one expects the central bank to abandon its ease policy.

The announcement is “a clear signal from the central bank that it wants to slowly start the process of exiting the extraordinary accommodation that remains in place,” said Kaushik Das, chief economist for India at Deutsche Bank AG . push the different short-term interest rates to gradually converge towards the reverse repo rate. “

The RBI assured markets in last week’s statement that it will continue to ensure adequate liquidity. The cash surplus in the banking system is currently around 6.7 trillion rupees, according to the Bloomberg Economics India Bank Liquidity Index.

Traders See India Cash Crunch To Boost Bond Reading Book

One- to three-month bill yields could increase by 15 to 18 basis points, while one-year ones could climb 10 basis points, according to Madhavi Arora, senior economist at Emkay Global Financial Services Ltd.

The collapse in short-term rates has increased the risk of distortions in asset pricing by banks and a further steepening of India’s yield curve, which is of concern to policymakers.

After the market’s initial reaction to the RBI’s statement, attention will turn to Friday’s reverse repo auction. The cutoff rate at which the central bank accepts the offers will be a key signal of the interest rate trajectory, according to a Kotak Mahindra Bank note.

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