The chances of an interest rate hike, the first of this cycle, at the next monetary policy review scheduled for October 5-7 have increased after the Reserve Bank of India announced a 30-day variable rate reverse repo (VRRR) auction for a notified amount of ₹7 trillion on Monday, with the reversal date coinciding with the policy review.
Liquidity surplus in the banking system hit a fresh record of ₹10.3 trillion on Thursday, surpassing the previous high of ₹9.7 trillion on Wednesday.
Amid the influx of over $136 billion under the RBI’s concessional swap window, India’s foreign exchange reserves rose to a record $740.8 billion for the week ended August 28. The rupee gained 0.94 per cent this week versus the greenback and 1.3 per cent since June 8, when the swap schemes were operationalised.
The reserve buildup has been led by foreign currency assets (FCAs), the largest component of the reserves, which have risen by nearly $60 billion over the past nine weeks to $601 billion. Overall reserves have increased by $73.9 billion during the nine-week streak, taking them well above the previous record of $729.3 billion reported a week earlier.
The run is the strongest since April-June 2021, when reserves rose for 10 consecutive weeks, although the increase then was smaller at $31.2 billion.
The RBI, according to experts, is facing delicate policy choice amid the liquidity glut: Absorb excess cash without putting further pressure on financial markets, or turn to interest rates to tackle continuing strains in the rupee and bond market. Dealers said Monday’s VRRR auction, particularly its provision for premature reversal, should ease concerns about further liquidity-tightening measures ahead of the October policy meeting.
The central bank sweetened the auction by allowing banks premature reversal of the funds they had parked — a first for such an auction. “Request for premature reversal can be placed at least two working days prior to the original date of reversal,” the RBI said while announcing the auction.
The move is expected to bring relief to the bond market, which had been bracing for further liquidity-tightening measures, dealers said. “This means no more measures until policy. The rupee has remained under pressure, bond yields have stayed elevated, and liquidity in the banking system is skewed, with this, a rate hike now seems like the most preferable tool for the RBI,” said the treasury head at a private bank.
The rate hike possibility first surfaced with the release of the August Monetary Policy Committee meeting’s minutes, in when members indicated risks to inflation becoming broad based given buoyant demand.
The option of premature reversal could also make banks more willing to commit funds for the full 30-day tenor, market participants said. Lenders had been reluctant to lock in liquidity for longer amid tax outflows expected later this month.
“With the option to seek premature reversal if liquidity is needed, banks may be more comfortable parking funds for the full tenor, supporting demand,” said a dealer at a primary dealership.
Another dealer at a state-owned bank said the partial reversal option should provide relief to the market because it indicated that there may be no further liquidity measures before the October Monetary Policy Committee meeting. The yield on the benchmark 10-year government bond could open 2-3 basis points lower, the dealer added.
The record reserves are largely a consequence of the foreign currency non-resident (bank) — or FCNR(B) — deposits mobilisation, under which banks raised $127.2 billion through the concessional swap facility. Although the deposit mobilisation window closed on August 31, banks can avail themselves of the swap facility for deposits already contracted with the central bank until September 11.
That means the reserve accumulation has further to run. Economists expect additional inflows to lift FCAs — expressed in dollar terms and include the effect of appreciation or depreciation of non-US currencies such as the euro, pound and yen held in the reserves — to about $640-650 billion in the coming weeks.
“Foreign currency assets should go up from here as inflow will come in by September 11,” said Madan Sabnavis, chief economist at Bank of Baroda. “We should be getting at least a total of $100-110 billion, taking the total to around $640-650 billion FCAs,” he added.
The window for FCNR(B) deposits closed on August 31, while external commercial borrowings (ECBs) and overseas foreign currency borrowings (OFCBs) remain eligible under the facility until December 31, 2026.