Informist, Tuesday, Dec 7, 2021

By T. Bijoy Idicheriah

MUMBAI - Even as many market participants are pencilling in a reverse repo hike by the Reserve Bank of India, the central bank is more focused on "cleaning up" the flows into the fixed rate reverse repo and transitioning it to variable rate reverse repos where it has more control, a banking industry source said.

"There is still one or two lakh crores (1-2 trln rupees) in the fixed rate reverse repo. As long as that is there, what is the point of a reverse repo rate hike?" the source told Informist.
 

The source said the repo rate is the main monetary policy rate that is used to target cost of funding in the economy and keep retail inflation within the range of 2-6%. Instead, the RBI sees the reverse repo rate as a passive liquidity absorption tool, which has no bearing whatsoever on inflation or liquidity. 

The RBI has been clear that it wants to move the market away from parking liquidity in the fixed rate reverse repo window, as that is a standing facility over which it has little control, to variable rate options which it can modulate to ensure better control over excess liquidity. 

To achieve this, the RBI has increasingly moved absorption of excess liquidity through larger quantum of variable rate reverse repo. Of the 8.34 trln rupees of excess liquidity, almost 7.20 trln rupees is getting parked into such variable rate windows.

Through introduction of variable rate reverse repo auctions, the RBI managed to move the bulk of the excess liquidity that was being parked in the fixed rate reverse repo to the variable rate options.

As the tenors of the variable rate reverse repo vary from a few days to 28 days, there is a tenor premium built in, and the weighted average variable rate reverse repo borrowings are almost close to the highest possible rate of 3.99%.
 

When the fixed rate reverse repo is included, the weighted average reverse repo rate is close to 3.80% which is well above the 3.35% reverse repo rate. 
 

"The liquidity programme is proceeding as per plan, and everyone sees the plan and is on the same page. There is a method to the madness which is non-disruptive," the source said.

When pointed out that borrowings in windows such as Triparty Repo Dealing and Settlements were happening at a sharp discount, which has been cited as a reason why RBI should consider a reverse repo rate hike, the source said that there is some tightening being faced in that segment too. 

On the day of Goods and Services Tax payments, the rate in this segment had also tightened to 3.5%, which meant that the overall situation is tight and even a minor exogenous change can lead to a sharp uptick in rates in TREPS. 

One of the country’s largest banks was actively indulging in the arbitrage between the TREPS window and other liquidity markets, since the opportunity has been structurally provided, the source said. 
 

"Suppose RBI moves on reverse repo and call money rate stays below Liquidity Adjustment Facility, RBI will not look good. This is because it is through call money that RBI transmits to the rest of the economy," the source said. 

Even as the COVID-19 pandemic has impacted how call rates move, the RBI has traditionally cited weighted average call rate as the key benchmark to gauge monetary policy rate transmission into the economy. 

Going ahead, once the RBI deals with the extent of flows into the fixed reverse repo rate, then even without setting limits on flows into this window, it will wrest back control over excess liquidity. 

"If you clean the fixed rate reverse repo, then you focus on the VRRR (variable rate reverse repo). No need to set any limit on overnight reverse repo. The problem of securities exists, so it will go into the options. Most people will take what VRRR option is available. Then RBI will have control."  End  

Edited by Akul Nishant Akhoury

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