The Reserve Bank of India (RBI) maintains its focus on liquidity conditions in monetary policy, with the aim of keeping overnight rates near the marginal standing facility (MSF) rate at 6.75 percent, rather than the repo rate at 6.50 percent. This approach has been implemented through various measures, including the incremental cash reserve ratio (I-CRR), which temporarily withdrew Rs 1.1 lakh crore of liquidity in August.
The phased removal of I-CRR throughout September and early October has contributed to maintaining tight liquidity conditions. This has led to a liquidity deficit averaging Rs 1 lakh crore daily in the latter part of September, causing overnight rates to rise to the MSF rate, which is 25 basis points higher than the repo rate.
The RBI has also suggested the potential use of open market operations (OMO) for liquidity absorption, with the specific amount contingent on current conditions. This has been interpreted by the markets as a signal for yields, resulting in higher government security yields.
The RBI’s determination to uphold tight liquidity is further evident in its actions, including unannounced OMO sales in September and references to OMO auctions in periods of constrained liquidity.
The combination of a stronger dollar and elevated crude oil prices, coupled with evolving changes in the external balance of payments, may contribute to ongoing liquidity tightening. The festive season leads to increased currency circulation, underscoring the RBI’s commitment to maintaining liquidity conditions.
Regarding inflation, Q2 has witnessed increased inflation pressures, primarily due to spikes in vegetable prices. While this inflation is expected to moderate in H2, it is anticipated to remain above the 4 percent mark, as per the RBI’s projections.
The RBI’s objective is to facilitate better transmission of previous policy rate hikes, which are yet to fully manifest in the financial system. Consequently, the policy stance is perceived as a withdrawal of accommodation, highlighting the need to maintain tight liquidity conditions and ensure overnight rates remain close to the MSF.
Although the India and U.S. Treasury (UST) yield differential has narrowed due to the Federal Reserve’s aggressive rate hikes and increased U.S. government debt, India’s inclusion in a global bond index has offset the impact on G-Sec yields. However, if the RBI proceeds with OMO sales, it could result in a near-term increase in G-Sec yields, potentially reaching 7.45 percent, thereby supporting the yield differential.
In conclusion, the RBI’s monetary policy underscores liquidity management and improved policy transmission, while the evolving economic landscape, inflation dynamics, and external factors continue to influence its approach.