Excess liquidity forcing market rates below policy rates

MUMBAI: It is a problem of plenty for the Reserve Bank of India -- be it the US dollar or Indian rupee. The excess liquidity is forcing market rates below policy rates and the sustained dollar inflow is making matters worse, challenging RBI governor's status quo on interest rates awaiting monsoon’s impact on food prices.
The inter-bank call rate, at which banks borrow and lend overnight, has dipped to 6.80%, 45 basis points lower than the benchmark repo rate at 7.25%. Normally, the spread or gap remains in the range of 15-25 bps. A basis point is 0.01%.

“RBI liquidity management looks well balanced, be it through OMO sales or FX forwards markets,” said Ashish Vaidya, executive director and head of trading and asset liability management at DBS Bank. “An OMO sales with short-term paper will not really upset the benchmark yield while RBI could extend dollar buying from forward markets instead of spot market.”

In the past two weeks, the system liquidity is showing no signs of liquidity stress. On many occasions, it has turned surplus by about Rs 5,000-15,000 crore, which means banks have parked net surplus funds with the central bank instead of borrowing from it.

More than a week ago, RBI had already conducted Rs 10,000 crore open market sales to suck out liquidity.

Now, some large public sector banks were seen buying dollars from forward markets in the lot sizes of 400-600 million in the past one or two weeks, dealers said. The central bank is suspected to be behind the move as any exchange rate intervention in the spot market would have led to injecting higher liquidity in the system.

“During May, liquidity was tighter, as a result RBI took delivery of its forward positions,” said Anindya Banerjee, currency analyst, Kotak Securities. “But, since June, ample liquidity meant RBI had to focus on forward market over spot, while buying dollars.”

So far in July, foreign portfolio investors net invested Rs 8,619 crore in Indian securities against Rs 1,608 net sold in June.

“The excess rupee liquidity can be controlled by reducing intervention in the spot market,” said KN Dey, executive director at Mecklai Financial. “If RBI is trying to mop up dollars in forward market, this could be aimed at repayment of FCNR deposits falling due in November next year (for about $40 billion).”

The rupee has appreciated reasonably on trade weighted basis. In Real Effective Exchange Rate or REER terms, the rupee is considered to be overvalued. The index stands at 109.9 (may number), leaving room for dollar buying.