The possibility of a policy repo rate hike has increased following the release of the Monetary Policy Committee’s (MPC’s) minutes, which were seen as hawkish. Economists now see October as a possibility, against earlier expectations of a rate action in the next financial year.
The case for an incremental CRR comes amid rising surplus liquidity in the banking system. Core, or durable, liquidity is expected to increase further as government spending picks up ahead of the festival season. Overnight benchmark rates —weighted average call rate (WACR) for the triparty repo (Treps) rate —have already been trading below the repo rate despite the RBI conducting daily variable rate reverse repo (VRRR) auctions to absorb excess liquidity. VRRR auctions are aimed at draining transient liquidity.
“But before that RBI may have to tackle surplus liquidity. Durable or core liquidity may cross ₹9 trillion and even hit ₹10 trillion over the next few weeks. System liquidity will also rise as government spending picks up speed,” Prasanna said, adding, “Hiking repo rates without enforcing them would be counterproductive. The RBI may have to use long-term instruments like CRR hike, open market operation (OMO) sale or forward swaps to remove durable liquidity for an extended period.”
The weighted average call rate, the operating target of monetary policy, closed at 5.18 per cent on Tuesday. Banks were closed on Wednesday for Milad-un-Nabi.
The RBI last used iCRR in August 2023, when it directed banks to maintain an incremental 10 per cent reserve on the increase in their net demand and time liabilities between May and July. The measure was aimed at absorbing more than ₹1 trillion of surplus liquidity generated by the return of ₹2,000 notes to the banking system, the RBI’s surplus transfer to the government, and strong capital inflows.
The central bank subsequently phased out the iCRR in three stages between September and October 2023 as liquidity conditions eased.
Market participants said the RBI has several options to absorb durable liquidity, including dollar intervention through spot or forward sales, CRR-linked measures and OMO bond sales. The choice of instrument would depend on the segment of the yield curve the central bank wants to influence, they said.
“ICRR is a possibility. It depends on the objective. If the objective is to tighten yields a little at the long end, then you would use OMOs. If the objective is to put pressure on the short end of the curve, you would use CRR. While CRR would have an impact across the curve, its impact would be larger at the short end,” said a market participant.
Market participants also said communication would be important if the central bank decides to impose an incremental CRR, as they expect the instrument to be used for a shorter period, as it was last time. During the post-policy media interaction earlier this month, RBI Governor Sanjay Malhotra said surplus liquidity may peak around September and should subsequently be absorbed by the normal liquidity needs of the economy.
Typically, monetary transmission is more effective when liquidity is in deficit during a tightening cycle, and vice versa.
