“It appears the liquidity situation is being kept in line with the accommodative stance of the RBI’s current monetary policy, which will ensure that the transmission of rate cuts happens much faster,” Chakraborty told CNBC-TV18.
Chakraborty said that while earlier the central bank used to respond to market-based indicators like overnight rates or the spread on three-month certificates of deposit, its current focus has shifted. Now, the RBI seems to be targeting a specific liquidity surplus level, around 1% of banks’ net demand and time liabilities (NDTL), irrespective of short-term rate signals. “The RBI is building towards that 1% of NDTL type of liquidity surplus as they move forward,” he noted.
Part of the market buzz has been around whether the RBI’s actions are driven by upcoming maturities of its $80 billion in forward foreign exchange positions. Chakraborty acknowledged that this could impact net liquidity, but said it’s hard to quantify the exact effect. “It’s very difficult for us to estimate the forwards part impact,” he said.
On interest rates, Chakraborty expects the weighted average lending rate to start dropping over the next few months, possibly dipping below 9%, driven by softening bond yields and stronger liquidity conditions. However, the benefit of further rate cuts may show up more on shorter-term bond yields than at the longer end, where there’s less room left for compression.
The RBI’s ₹2 trillion dividend to the government, expected in May, will further boost durable liquidity in the system, Chakraborty pointed out. Though this will not immediately reflect in interbank liquidity, since the government takes time to spend the funds, it will eventually help ease rates further.
He also clarified that despite bond yields already falling and liquidity looking comfortable, the RBI’s ongoing OMOs are likely part of a longer-term plan. “Despite the significant OMOs that the RBI has already done, the durable liquidity surplus is still lower than that 1% of NDTL,” he said.
On the rupee, Chakraborty expects a stable outlook with only marginal depreciation. With inflation differentials narrowing and India holding healthy forex reserves, he believes the rupee can be managed within a narrow band for the foreseeable future.
Overall, he sees the RBI’s moves as consistent with a strategic shift, from reacting to price signals to managing liquidity at a targeted level, all while ensuring that rate cuts flow more efficiently through the financial system.
Below is the verbatim transcript of the interview.
Q: First of all, were you surprised by the announcement?
Chakraborty: As things go, these OMO announcements have been much higher than where the market expectations were. And I guess the primary reason behind this is that in earlier instances, the market was looking at different kinds of overnight rates and the spreads of three-month CDs over overnight rates to understand whether there was liquidity stress in the system, or in other words, looking at the price of liquidity, to decide whether a liquidity infusion would be done by the RBI or not.
But now what appears to us is that the RBI has a certain quantum of liquidity target in mind, and they are gradually building up through these OMO purchases towards that liquidity target, regardless of where the price indicators of liquidity in the market are. The overnight rates are already lower than the repo rate. The three-month CD spread has collapsed almost 100 basis points from the highs about a month or so ago. So that’s not the primary reason for the OMO. The RBI is building towards that 1% of NDTL type of liquidity surplus as they move forward.
Q: Just to explain to my lay viewers, the thrust of the Reserve Bank, according to Samiran, is that they are no longer looking at yield levels. Initially, bond traders used to look at the yield levels, and if it went higher than the repo rate or something similar in the call market, then you would expect the Reserve Bank to intervene. Now, the Reserve Bank is intervening even though the yield is below the repo rate, and as he sees it, that’s because they want to keep the total amount of excess liquidity at 1% of total deposits, which is what NDTL means. But Samiran, therefore, what is their aim? Why would they want to keep that 1% NDTL? Is it for faster transmission of deposit rate cuts?
Chakraborty: So, it could be a mix of quite a few things. One possibility, simply, is that despite the significant OMOs that the RBI has already done, the durable liquidity surplus is still lower than that 1% of NDTL. We think that number is somewhere close to the ₹2 trillion mark, rather than the ₹2.5 trillion where probably that 1% of NDTL is. The banking system liquidity surplus, the frictional liquidity, is also not that big a surplus yet.
Now, the interesting thing is that in the month of May, the RBI is going to give a very large amount of dividends to the government, budgeted to be at least ₹2 trillion. That adds to the durable liquidity. At that point, the durable liquidity surplus would definitely cross that 1% of NDTL mark. Now, to what extent that injection of durable liquidity will be compensated by other types of liquidity absorption, whether in the form of higher currency in circulation, higher FX intervention, or, for that matter, a large amount of FX forwards that are coming up for maturity, will all determine where the final durable liquidity ends up.
Our sense is that, if the forwards mature, it’s very difficult for us to estimate the forwards part impact, but without that, the durable liquidity surplus could end up closer to ₹5 trillion. However, the banking system liquidity will not improve as quickly, because it takes some time for the government to use or spend the dividend that they receive from the RBI. But once the banking system liquidity improves, that’s when you’ll probably see more reaction on the deposit rate and lending rate side. And there, I guess the main issue is that if the bond yields come down, we have seen that with about a six-month lag, the weighted average lending rate also comes down. Given how the bond yields have behaved in the past, our sense is that within the next few months, we should see the weighted average lending rate fall below 9%.
Q: Can you give us some idea, therefore, of where you expect the 10-year bond yield and the rupee to range over, say, the next two quarters?
Chakraborty: Our sense is that right now, there is a possibility that the 10-year yield comes below 6.30%, which was our initial target set long back. That’s because the rate action, as well as the liquidity action, has been more than what we had anticipated at that point in time. However, we have to also be cognisant of the fact that in all earlier rate-cutting cycles, typically the term spread, the spread between the 10-year bond yield and the policy rate, widens further.
So, that’s why we think the bulk of the reaction from future rate cuts, at least 50 basis points more rate cuts could be there, that could be felt more at the short end of the curve rather than the long end. Although we have to see which particular segments the OMOs are targeting, as that might also impact yields. But overall, we’re not expecting major action at the long end. More action at the shorter end is what our sense is.
On the rupee, I think it’s a tussle between where the dollar is going versus where the CNY is going. But our sense is that, at this point in time, the bias is toward a very marginal depreciation, but a more range-bound rupee movement. This is because the inflation differential is collapsing quite significantly for India, and the fact that we have now built up substantial reserves as well, our ability to keep the rupee in a relatively narrow range is much better now.
Q: There is one group of bankers who feel that because the RBI has $80 billion of forward buy-sell positions, and maybe a large part of it is maturing, that is why this money is being infused. And then there’s the other group, who say what you’re saying, that there will be cash withdrawal, CRR money going away, etc. What do you think is the reason? Is it more the FX reason, or is it more about cash withdrawal, CIC, and other factors?
Chakraborty: As I was saying, without considering the forwards position, the durable liquidity could end up close to ₹5 trillion by the end of the quarter. So, it’s possible that the actual increase will not be that much because some forward positions are also being extinguished. But it’s very difficult to take a definitive call on how far the RBI will go on this front.
There is room for the RBI to take this approach because the overall durable liquidity surplus is going to be significant, so they would not be too concerned on that front. But I must say that it appears the liquidity situation is being kept in line with the accommodative stance of the RBI’s current monetary policy, which will ensure that the transmission of rate cuts happens much faster.