Ever since overnight money rates in the Indian money markets have crashed, sometimes to as low as 0.01% per annum, analysts have been expecting measures from the Reserve Bank of India to bring it back to normal levels (within the LAF band of 6% - 7.75%). Surprisingly, except for the odd small additional government borrowing (which is managed by the central bank), RBI has maintained complete silence on the issue.
Many analysts have even expected (or called for) another hike in the cash reserve ratio (CRR).
In my view, the central bank would be very wary of using a blunt instrument like an increase in the CRR. It’s ability to conduct open market operations is also limited, since the amount of securities held on its books are generally insufficient to effectively conduct one. And, on the issue of market stabilization bonds (MSS), it is fast approaching the limit it set for itself. It therefore has little choice but to let the liquidity remain within the system.
A consequence of the humongous liquidity, is that this effectively puts a break on the upward bias of the Indian rupee (INR) in the currency market. Personally, I feel that the central bank has allowed the excess liquidity to remain in the system to ensure precisely this. In other words it is focusing on a policy of exchange rate management rather than liquidity (in other words inflation) management, at least for the time being.
The softening of the inflation readings (the last figure came in at 4.28%, well within the comfort zone of the central bank) has also helped them to continue following this policy.
Overnight rates should head back to normalcy, once the stake held by RBI in the State Bank of India is transferred to the Government, before the end of this month. This transaction is worth more than INR 350 bn. Effectively that much money will leave the banking system.
All the more reason why I do not expect a hike in the CRR.
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