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The Reserve Bank of India

The Reserve Bank of India (RBI) is expected to take further actions to alleviate the banking system’s liquidity deficit, which has remained consistently above Rs 3 lakh crore in recent weeks.

RBI's bold liquidity measures signal rate cut in February, shift towards easing

To tackle liquidity crunch which has reached almost Rs 3 lakh crore, the RBI unveiled a three-pronged approach, consisting of Rs 600 billion in open market operations (OMO) purchases, Rs 500 billion through a long-dated variable rate repo (VRR) auction, and a $5 billion buy/sell swap auction.

Despite the central bank’s recent measures, including Open Market Operations (OMO), a 56-day repo auction, and a $5 billion USD/INR swap, the liquidity gap remains substantial. These initiatives were designed to inject Rs 1.5 lakh crore into the system, with additional support anticipated ahead of fiscal year-end pressures.Economists and market participants expect the RBI to pursue additional liquidity measures, especially in light of the significant liquidity deficit. One key focus is the potential relaxation of the Liquidity Coverage Ratio (LCR) norms.

Indian banks face slowing credit growth amid high rates, cooling economy: S&P Global

Aggregate loan growth at six of the country’s largest banks, both private and state-owned, is projected to decelerate to 12.3% in the fiscal year ending March 2025, down from 22.5% in the previous year.

The current LCR proposal requires banks to reallocate approximately Rs 7 lakh crore from loans to government securities or liquid assets, a move that could strain the system further. Market observers believe the RBI may ease these proposed tightening measures, providing additional liquidity relief to banks.The deficit is expected to improve to around Rs 2.4 lakh crore by the end of FY25, with further liquidity injections required to close the gap. The RBI is likely to continue these measures, including scheduled OMO purchases of Rs 60,000 crore across three tranches in January and February, alongside additional 56-day repo auctions.

Analysts expect the RBI to closely monitor developments and may adjust its liquidity-management framework as needed. While the central bank has shifted its stance to a more neutral position, the February policy meeting will be critical for further guidance on future rate cuts and liquidity management strategies.

The measures

The RBI’s latest liquidity measures come amid heightened concerns over tight liquidity, particularly at the close of the financial year when banks typically face higher demand for funds. Recent actions include a calendar for open-market bond purchases, marking the first such move in five years, alongside the introduction of a 56-day variable rate repo auction, which allows banks to secure funds until the end of the financial year.

The RBI also announced a $5 billion USD/INR buy-sell swap, aimed at mitigating the impact of upcoming forward book maturities.

The RBI’s actions indicate a shift in its approach to liquidity management. The recent liquidity easing measures, particularly the OMO and repo auctions, are seen as setting the stage for future interest rate cuts.

Nomura, for instance, forecasts a 25 basis points rate cut in February, followed by a 100 basis points reduction in 2025, bringing the repo rate to 5.50% by the end of the year. This could signal the beginning of a broader monetary easing cycle, with further rate cuts anticipated if inflation and economic conditions warrant such moves.

The central bank’s liquidity operations are designed to address the core liquidity deficit, which has entered negative territory for the first time since 2019.

Short-term relief

In the short term, the RBI’s OMO auctions and repo operations are expected to ease market tensions, with bond yields likely to remain within a tight range. The yield on the 10-year benchmark bond softened earlier but ultimately ended slightly higher, reflecting market participants’ profit-taking in anticipation of further policy actions.

Market expectations suggest that the yield will fluctuate between 6.65% and 6.7% until the Union Budget, with the possibility of additional liquidity measures driving yields lower in the medium term.

  • Published On Jan 30, 2025 at 08:00 AM IST

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