RBI’s liquidity steps raise hopes for a rate cut next week

Mumbai: Relief arrived for India's parched banking system on Monday as the central bank rolled out measures to pump up liquidity, setting the stage for a potential interest rate cut next week.

The Reserve Bank of India (RBI) announced a set of forex and money market measures that will collectively infuse ₹1.5 trillion over time, amid a clamour for liquidity from multiple bankers and money market participants.

The central bank said it will purchase government securities (G-Secs) worth ₹60,000 crore through open market operations (OMOs) in three tranches of ₹20,000 crore each. Through this measure, RBI will purchase G-Secs from the open market and inject liquidity into the system. The OMO auctions will take place on 30 January, and 13 and 20 February.

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In addition, it will also conduct a 56-day variable rate repo (VRR) auction of ₹50,000 crore on 7 February and dollar-rupee sell swap auction of $5 billion for a tenor of six months on 31 January. The VRR aims to ensure sufficient liquidity to meet banks' needs till 31 March. Under the dollar-rupee swap, RBI will buy dollars from banks in exchange for rupees, which will be released into the system. After six months, RBI will sell the dollars.

Deficit crosses ₹3 trillion

Average liquidity deficit crossed ₹3 trillion last week, thanks to heavygoods and services tax (GST) outflows. The central bank has been intervening heavily in the forex market to keep rupee less volatile over the last two years. However, the currency began depreciating sharply since September, as foreign portfolio investors aggressively selling Indian stocks scooped up dollars to send money home.

The RBI said it will "continue to monitor evolving liquidity and market conditions and take measures as appropriate to ensure orderly liquidity conditions." Liquidity deficit has remained above ₹1 trillion since December due to slow government spending.

Bankers and economists said these measures will help relieve the current liquidity shortage and set the stage for a repo rate cut next week. With the money stock increasing through these measures, RBI will find it meaningful to reduce the price of money with a rate cut, they said.

“Given the persistence of liquidity deficit, RBI has announced the liquidity-easing measures on expected lines. However, we expect more easing will be needed given the continued pressure over the next few months. The liquidity-easing measures also increase the probability of repo rate cut in the upcoming February policy,” said Upasna Bhardwaj, chief economist, Kotak Mahindra Bank. The central bank's monetary policy committee (MPC) meets from 5 to 7 February.

Interestingly, RBI has scheduled the 56-day VRR on the day of the monetary policy announcement, also signalling the possibility of a rate cut.

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Over the past two weeks, RBI has taken steps to provide liquidity. It introduced daily variable repo rate auctions on 16 January, bringing down overnight call money rate closer to the repo rate of 6.5%. The overnight call money rate had jumped by 75 basis points earlier this month.

RBI also conducted a direct OMO purchase of ₹10,000 crore, showed data on 24 January. The OMO calendar released on Monday will provide the much-needed certainty to the market about RBI's liquidity operations.

While the latest liquidity infusion of ₹1.5 trillion is unlikely to completely plug the current deficit, a section of bankers and economists said that RBI could announce a further cut in cash reserve ratio (CRR) by 50 basis points next week. RBI had already cut CRR by 50 basis points in the December policy.

Showing intent

"These measures show the intent of RBI to provide liquidity till 31 March. We do expect a repo or CRR cut or a combination of both next week," the treasury head of a large bank said on the condition of anonymity.

With inflation closer to 5% and the rupee depreciating to record lows, some analysts are, however, deferring expectations of a rate cut. They expect RBI to asses the impact of US president Donald Trump's actions first before deciding on a rate cut.

"Liquidity will improve with these measures. However, the fundamental issue is growth in deposits relative to credit. Depending on the liquidity situation on 5 February, a call can be taken on a cut in CRR. However, under these conditions, in my view, liquidity should be normalized before considering a repo cut, as external benchmark lending rate (EBLR) means direct transmission. Hence, imperative liquidity is normal," said Madan Sabnavis, chief economist, Bank of Baroda.

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Meanwhile, there are doubts if a rate cut alone will revive demand.

"While a repo rate cut will boost sentiment, it is unlikely to have a big impact on demand conditions because the cumulative room to ease monetary policy is limited. A rate cut by India in the backdrop of rising US interest rates could potentially weaken the rupee further and complicate inflation management in FY26. It's important for the central bank to strike a balance between risk (of currency depreciation) and reward (from a limited boost to growth)," said Vivek Kumar, economist, QuantEcoResearch.

The yield on the 10-year government bond closed four basis points down at 6.68% on Monday, while the rupee closed up 13 paise at 86.338.