Central bank rate hike: liquidity withdrawal expected as RBI saw rates rise on Wednesday

Measures to tighten liquidity are expected to accompany a hike in Indian interest rates on Wednesday, adding upward pressure on bond yields and increasing the need for central bank action to support government borrowing.

The rise in interest rates is not in doubt, as the Governor of the Reserve Bank of India (RBI) declared on May 23 that the decision would be “a no-brainer”.

Economists polled by Reuters expect an increase of 25 to 75 basis points. It will follow a 40 basis point rise in May that kicked off the central bank’s tightening cycle, which economists expect to be relatively short.

“A rise at this week’s RBI policy meeting is a foregone conclusion,” said Radhika Rao, senior economist at DBS Bank.

“Inflation has been consistently high over the past three years, even as the drivers have changed – from supply bottlenecks to staples and reopening pressures,” she added. .

Retail prices in April were 7.79% higher than a year earlier, beating the RBI’s tolerance range for inflation of 2% to 6% for a fourth consecutive month. Inflation is expected to remain high in the near future.

RBI Governor Shaktikanta Das said late last month that the bank’s main objective was to bring inflation closer to target, but it could not ignore concerns over the economic growth.

The market expects a rise of around 50 basis points on Wednesday.

Analysts also expect the RBI to reduce liquidity, step up its fight against inflation and expand its efforts to bring monetary conditions back to where they were before the pandemic prompted sweeping action to boost the economy.

“We see the RBI continuing with its liquidity absorption measures,” BofA Global Research said in a June 3 note, predicting a 50 basis point increase in the cash reserve ratio (CRR) for banks, which would absorb about 870 billion rupees. in the banking system.

DBS’s Rao said: “Further CRR increases are being considered to reduce excess liquidity and ease transmission” – that is, to help interest rate hikes affect the economy.

Tighter liquidity will put upward pressure on bond yields. The benchmark 10-year yield has already risen more than 100 basis points in 2022, driven by global oil prices and rising expectations for short-term interest rates.

Meanwhile, the government is increasing its financing needs with fiscal measures to contain inflation, such as reductions in customs and excise duties on fuel. Economists believe that such fiscal action will have to continue.

The central bank may therefore have to support it by returning to buying bonds and thus keeping yields low.

“Asset purchases through G-SAP (the government securities acquisition program) could be reintroduced if the central bank deems it justified to contain fiscal risks,” said Shilan Shah, senior Indian economist at Capital Economics. .

In April, the central bank raised its inflation forecast, saying average retail prices for the year to March 2023 would be 5.7% higher than a year earlier. Economists expect it to raise the forecast further on Wednesday.

But the 2022/23 gross domestic product forecast will likely remain unchanged at 7.2%, they say.

Leave a Comment

Your email address will not be published.

%d bloggers like this: