From Live Mint
Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan and his deputies will meet bankers on Tuesday to discuss the prevailing liquidity situation and whether the central bank needs to relook its liquidity management, said two bankers on condition of anonymity.
One of the topics that could be discussed, although no clear agenda has been communicated to the bankers, is the lack of impact of the central bank’s rate cuts on bond yields, both long-term and short-term, and whether the liquidity deficit is indeed disrupting transmission of rate cuts.
The meeting comes after Rajan unexpectedly said on 2 February that liquidity is adequate and the central bank has been supplying enough funds for the market to meet its cash requirements which was in stark contrast to what most bankers believed. Citing rising bond yields, increase in Treasury bill yields and money market rates, bankers had said that a liquidity crunch has prevented yields from falling commensurate with the RBI’s rate cuts, a cumulative 125 basis points (bps) in 2015. One bps is a hundredth of a percentage point.
“I think they have realized now that the problem is serious and they are willing to have a discussion,” said a senior banker, asking not to be named.
That the RBI and markets have taken opposing stance on liquidity and rates is not new. However, the central bank’s reluctance to affirm the rising liquidity deficit in the banking system has taken many by surprise. “The real debate is whether it is sustainable to have a prolonged deficit to such an extent,” said the banker.
On 2 February, following the release of the bi-monthly policy, Rajan said that it is incorrect to say there is a liquidity crunch and that the RBI has been supplying funds for the banking system to meet its requirements. Indeed, the cumulative borrowings of banks from the central bank’s various liquidity windows was an average of more than Rs.1.2 trillion so far in 2016.
According to Rajan, the benign weighted average call money rate is proof enough that there is no dearth of liquidity. The weighted average call rate has remained largely close to the prevailing repo rate, which is currently at 6.75%. However, bankers said that this rate could be misleading given the volatility in call rate during a trading session. The interbank call money rate, an unsecured overnight borrowing accessible to banks, shot up by 60 bps on Monday to a high of 7.65%. The weighted average of the rate was 7%. On Monday, the overnight call rate moved between 6.80% and 7.65%.
Tight liquidity has kept bond yields firm despite the rate cuts by the RBI. Although bond yields eased 150 bps between May 2015 and October 2015, they have bounced back to levels seen before the RBI began its interest rate cuts in January 2015. The benchmark 10-year government bond yield settled at 7.80% on Monday, its highest level since August 2015.
Similarly, rates on commercial papers (CP), Treasury bills and even corporate bonds have hardened. Three-month CP rates are up 135 bps from their 2015 lows hit in September last year to trade around 9% currently. The 91-day Treasury bill yield has jumped 30 bps and had prompted the RBI to reject all bids at a recent auction.
To be fair, the RBI has infused about Rs.30,000 crore of permanent liquidity into banks through bond purchases under open market operations (OMO) which it restarted in December. But bankers insist that OMO bond purchases are woefully short. Bank of America Merrill Lynch estimates in a 3 February report that the RBI would have to infuse $5 billion more through such OMO purchases by March.