Interest rates may dip ahead of policy rate cuts on excess liquidity

MUMBAI: Interest rates may dip even before the Reserve Bank (RBI) next cuts rates as a government flush with funds is likely to fill the system with liquidity through project spending while borrowing less from the markets. “Tax collections and RBI dividend giving the government additional funds are likely to add to liquidity in the system,” said Badrish Kulhalli, fund manager, fixed income, at HDFC Life Insurance. “This will lead to a reduction in short-term rates ahead of policy rate cuts.”

The central bank paid the government a dividend ofRs 65,896 crore, a record high. Indirect taxes collection grew 39.1% in July and 37.6% in April-July from a year earlier, the finance ministry said on August 12. “Those actions will improve the government’s fiscal position and fiscal consolidation will happen faster,” said R Sivakumar, head, fixed income at Axis Asset Management.

The 10-year benchmark bond yield fell six basis points, pushing prices up, after the RBI approved the dividend payment on Thursday. The sovereign yield closed at 7.74% on Friday. The benchmark policy repo rate is currently at 7.25%. With inflation falling, the RBI may cut the rate by another 25 bps in its next policy.

“It is expected that the government will use the additional revenue towards infrastructure spending rather than showing a lower fiscal deficit number,” said Mohan Shenoi, executive vice-president at Kotak Mahindra Bank. “If there is surplus liquidity in the system, the RBI might sterilise it through OMO (open market operation) sales.”

The RBI may sell sovereign bonds and suck out excess liquidity as the central bank expect rates to move in line with the policy rate, without sharp swings. The central bank conducted OMO sales for Rs 8,000 crore in the primary market a month ago.