After Fed surprise, markets await liquidity easing by RBI

US Federal Reserve chief Ben Bernanke’s act of kindness has fuelled hopes of some leeway from Raghuram Rajan, governor of the Reserve Bank of India (RBI), as he spells out his maiden monetary policy review on Friday.

While the central bank may not change the policy rate in the mid-quarter review, it is highly expected to ease liquidity conditions that have been running into average deficit of Rs 1.07 lakh crore daily this month. The RBI has held on to policy rates since May 2013, citing inflationary pressures from falling rupee.

At present, repo rate, or the rate at which banks borrow from RBI, stands at 7.25%. The marginal standing facility (MSF) which banks use on non-maintenance of statutory liquidity ratio (SLR), was hiked by 200 basis points to 10.25% in order to make short-term liquidity costlier and curb speculation in the foreign exchange market.

“We expect the RBI to reduce the MSF rate by 50 bps to 9.75%,” said Indranil Sen Gupta, India Economist at Bank of America Merrill Lynch. Banks use the MSF window to borrow funds at a penal rate for non-maintenance of SLR.

Reflecting the pressure on liquidity, the daily withdrawal from RBI’s MSF window had jumped to about `1.4 lakh crore due to advance tax outflows.

RBI had also capped banks’ borrowings at repo rate to 0.5% of net demand and time liabilities and increased the daily cash reserve ratio requirement from 70% to 99%.

Liquidity deficit in the system led to hike in interest rates on deposits and consequently on loans by banks in the private sector. Public sector banks followed with the latest hike coming from State Bank of India (SBI), the country’s largest lender.

Bankers hope that these measures would be rolled back, at least partially, since rupee has seen substantial appreciation. On announcement of Fed’s decision to defer the cutback of stimulus, the rupee scaled back 2.5% against the dollar in a day.

However, inflation and weak domestic fundamentals may keep RBI from switching to a dovish stance. “The ‘no taper’ decision has led to a spike in oil and gold prices, which will start to impinge on both the import bill and inflation. Policy makers may be lulled into a sense of complacency and slow the reform momentum,” said Sonal Varma, India economist at Nomura.