In a surprise move, the Reserve Bank of India (RBI) on Monday eased the liquidity tightening measures it had initiated earlier by reducing the marginal standing facility (MSF) rate by a further 50 basis points (bps).
“On a review of evolving liquidity conditions and in continuation of this calibrated unwinding, it has been decided to reduce the MSF rate by a further 50 basis points from 9.5% to 9% with immediate effect,” the RBI circular read.
Following this, short-term rates and liquidity in the banking system are both set to ease further, providing much needed relief to smaller, wholesale-funded banks.
MSF rate is the rate at which scheduled banks borrow funds overnight from the RBI against approved government securities. This rate comes into play once the banks have exhausted their borrowing limit (which is currently set at 0.5% of their net demand and time liabilities, or NDTL) under normal repo auction or the liquidity adjustment facility route.
This is the second time in a little over two weeks that the RBI has cut the MSF rate, bringing it to within 150 bps of the repo rate. The central bank had announced a 75 bps cut in its last monetary policy, on September 20.
RBI governor Raghuram Rajan had said on that day that the difference between the MSF rate and the repo rate would over time come down to 100 bps, which was the prevalent spread before the central bank’s exceptional move in July raised it to 300 bps in a bid to contain volatility in the forex market.
The reduction was, therefore, on expected lines, said experts.
“I think the RBI is going back to its old framework of making repo rate the operational policy interest rate. The RBI seems to be making a differentiation between inflation management and currency stability by tinkering both repo and MSF rates. While the reduction in MSF rate seems to show that RBI is confident of currency stability, the inflation stability still seems to be a concern. So, it wont be surprising to expect a 25 bps hike in repo rates going forward,” said Saugata Bhattacharya, chief economist, Axis Bank.
The RBI has further decided to provide additional liquidity through term repos of 7-day and 14-day tenor for a notified amount equivalent to 0.25% of NDTL of the banking system through variable rate auctions on every Friday beginning October 11.
Bhattacharya said, given that the combined borrowing through LAF, MSF, CBLO and other instruments was still crossing the 1% of NDTL mark, it seems the RBI thinks this is the right time to inject additional liquidity by starting term repo market.
The liquidity easing measures by the RBI will reduce short-term market rates and will aid smaller banks who are more dependent on wholesale funding.
Vaibhav Agrawal, vice-president - research, banking, Angel Broking, said the banking sector in general will react positively to the news. “The RBI move gives indication that short-term rates can come down further and is likely to benefit smaller banks that depend more on wholesale funds,” he said.