Nomura Global Markets Research described on Wednesday the Reserve Bank of India's Rs 1-lakh-crore variable rate reverse repo auction as "confusing", questioning the central bank's liquidity strategy just weeks after a jumbo rate cut.
Analysts at Nomura had expected the RBI to refrain from such liquidity-tightening measures in the near term, especially after the central bank front-loaded policy easing with a substantial 50-basis-point rate cut.
A day ago, the RBI announced it would conduct a seven-day VRRR auction on Friday. In VRRR auctions, the RBI absorbs excess liquidity from the banking system. Banks deposit surplus funds with the RBI through auctions and the interest rate is determined by competitive bidding, usually close to or above the reverse repo rate.
The VRRR announcement is the first since November last year and has come at a time when liquidity remains comfortably in surplus and when government spending is poised to inject even more funds into the market.
As on June 24, liquidity in the banking system was in surplus mode of Rs 2.59 lakh crore. The auction is likely to push short-term rates higher, with the Mumbai Interbank Offered Rate expected to settle in the 5.35–5.4% range.
Nomura had believed that the RBI would focus on supporting policy transmission by maintaining surplus liquidity and low funding-rate volatility. The sudden shift suggests that the RBI may be prioritising a literal policy objective, keeping the operative rate, which is the weighted average call rate close to the repo rate.
Additionally, a review of the liquidity management framework is ongoing and there have been many comments and suggestions that the RBI should move the operative rate to a secured rate, such as the Tri Party Repo Dealing System, which has been trading below the Standing Deposit Facility rate.
"We believe this approach is very academic and does not factor in market fluctuations and the implicit signal it provides," the report said.
"On balance, we find this confusing especially after the large 50bp cut, which was to front load policy easing. Additionally, the implicit market signal is that the bar for further cuts is even higher now," it said.
If the weighted average call rate settles around 5.30–35%, it will be important to see whether the RBI will continue to conduct additional VRRR auctions, the report said.
In the bond market, Nomura has trimmed its long position in the five-year government bonds on the back of limited catalysts following the VRRR auction.
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