RBI’s calibrated liquidity normalisation

NEW DELHI:  August’s policy meeting has tried to walk a tightrope in attempting to differentiate its liquidity manoeuvres from the accommodative policy rate stance, but economists say that the current stance may not prevail for too long. In fact, one dissent from MPC member Jayanth Rama Varma and the re-introduction of the variable rate reverse repo (VRRR) auctions are seen as the beginning of RBI’s shift from unconventional monetary easing.

On Friday, the RBI doubled the quantum of VRRR to a total of Rs 4 lakh crore and it is set to conduct four VRRR auctions worth Rs 13 lakh crore till September end. RBI governor Shaktikanta Das has clearly stated these auctions should not be interpreted as a reversal of the accommodative policy stance, but economists and the markets disagree.

“Recognising the excess build-up in systemic liquidity, we saw the RBI take its second step towards some form of liquidity normalisation. The first being the tolerance towards some upward adjustment in the 10-year yield in July,” noted Abheek Barua, chief economist, HDFC Bank. Daily systematic liquidity surplus has increased from Rs 4-5 trillion in May to more than `8 trillion in August led by a slowdown in currency in circulation.

Aurodeep Nandi, economist, Nomura, too, concurred. “We believe that the liquidity manoeuvres suggest, at the very least, that the RBI is uncomfortable with a large amount of floating liquidity. As such, allowing bond yields to gradually rise and more VRRR issuance is the first step towards liquidity and policy normalization,” he said.

For RBI, the next step, Nandi added, would be to wean off from the durable injectors of liquidity, followed by a narrowing of the policy corridor and finally hiking the policy repo rate. “In our baseline, we expect a 40bp hike in the reverse repo rate in Q4 2021 (Oct-Dec), followed by 75bp of repo and reverse repo rate hikes in 2022.”