MUMBAI: Just months ago, the Reserve Bank of India (RBI) pulled out all the stops to draw in dollars in efforts to bolster its foreign-exchange reserves and defend the rupee. The stronger-than-expected deluge of cash is now adding to the case for a more hawkish monetary policy stance.
The record US$133bil inflow from the Indian diaspora left banks awash with cash and pushed overnight rates below the RBI’s 5.25% policy rate, effectively making borrowing cheaper than policymakers intend.
The liquidity surge came at a time when credit growth is accelerating, domestic demand is proving resilient while inflation is picking up.
Keen to prevent the excess liquidity from adding to price pressures, the RBI has drained more than one trillion rupees (US$10.4bil) through bond sales and other measures. Market participants expect it to announce further action in coming days.
At the same time, calls for an interest-rate hike next week are growing as rising food costs and elevated oil prices add to inflation pressures.
The prospect of a more hawkish RBI, alongside rising global bond yields, has driven Indian yields sharply higher and unsettled investors.
“It is important for the RBI to hike rates next week, take an appropriately cautious or hawkish tone to signal to markets that more maybe in the pipeline,” Sajjid Chinoy, chief India economist for JP Morgan Chase & Co told Bloomberg Television’s Paul Allen yesterday.
Chinoy added that the RBI should continue to aggressively absorb the excess liquidity to ensure that “there is no inadvertent monetary easing”.
Economists at Nomura Holdings Inc, Deutsche Bank AG, and Australia and New Zealand Banking Group are among those predicting the RBI’s first hike since early 2023 next week, with some bringing forward calls that previously anticipated a move in December.
The market is pricing in four hikes over a one-year period compared to three at the end of June, according to Abhishek Upadhyay, an economist at ICICI Securities Primary Dealership.
In September, surplus banking-system liquidity swelled to as much as 11 trillion rupees (US$115bil) as commercial banks swapped dollars for rupees with the RBI.
The move also pushed the RBI’s foreign-exchange reserves close to US$800bil, the world’s fourth largest.
Leaving that money unchecked could have a “credibility cost”, impede monetary-policy transmission and fuel mispricing of risk in asset markets, Citigroup Inc economists including Samiran Chakraborty and Baqar Zaidi wrote in a note.
Citi expects the RBI to steer overnight rates toward the repo rate, mainly through short-term foreign exchange swaps and other interventions that can temporarily drain liquidity.
It sees up to one trillion rupees of bond sales as an additional option, according to a research note on Sept 25.
While such interventions have helped the RBI’s cash drain efforts, they have also driven up the cost to guard against future rupee weakness, reflecting the market fallout of its attempts to counter easy financial conditions.
Deutsche Bank’s Kaushik Das said the RBI may raise the cash reserve ratio “as a last resort” if other measures fail to absorb enough liquidity.
Meanwhile, surging oil prices – Brent crude rose for a third month in September – is making matters worse.
The rupee is now trading near the levels seen prior to the RBI’s Foreign Currency Non Resident deposit plan, despite a steady stream of dollar-selling interventions by the central bank.
Down more than 6% year-to-date, it remains one of the worst-performing Asian currencies. Yesterday, the RBI sold more US dollars to support the rupee which was little changed at 95.8987 per dollar. — Bloomberg
