RBI announces measures to improve liquidity, cuts MSF rate by 50 bps to 9%

MUMBAI: RBI Governor Raghuram Rajan kept his promise of moving the money market to normal conditions as he cut the penal rate of interest, and took a step towards expanding financial markets by agreeing to lend to banks for a longer term.

The central bank reduced the rate under the marginal standing facility ( MSF) by 50 basis points to 9%, and introduced lending to banks for seven days and 14 days, instead of the current practice of just a day. The longer-tenor lending will begin October 11 at rates based on bids by banks. A basis point is 0.01 percentage point.

The measures are an unwinding of the liquidity tightening that began in July to fight a currency slide that took the rupee to a record low of 68.84 to the US dollar. The governor, who raised the repo rate last month, may keep interest rates high, or even raise them to show his determination to curb rising prices. The repo rate is the one at which RBI lends to banks.




“These are unwinding of the extraordinary measures taken to stabilise the rupee, and now that the rupee has stabilised, he is passing on some of the benefits,” said Jayesh Mehta, head of global markets at Bank of America Merrill Lynch. “These will increase liquidity in the system.”

Since July 15, RBI had made borrowing costlier as it believed that lower interest rates were used to speculate on the rupee, leading to its collapse. It reduced the amount banks can borrow against their excess government bonds holdings to 0.5% of the deposits, and increased the MSF rate by 200 basis points. It also raised the minimum cash reserve ratio to be maintained to 99%. Repo rate remains at 7.5%.

Those moves were not of much help in arresting the currency’s slide, but they bumped up interest rates by as much as 300 basis points, leading to investors losing thousands of crores of rupees. But Rajan had promised to return to normalcy, where the penal rates do not remain the norm for borrowings.

“Let me emphasise that the difference between MSF and repo rate will be brought down to 100 basis points,” Rajan said during the mid-quarter monetary policy review last month.

On September 20, Rajan reduced MSF by 75 basis points and raised the repo rate by 25 basis points citing inflationary pressure. He has warned that the rate increase may not be the last.

“We have to wait and look at economic conditions to determine what the next step will be,” Rajan had said. “It can be two-way, so it could be that we walk more on the MSF side, but it could be that the repo rate will do some of the walking.” The rupee has rallied 10% since its record low as US dollar inflows increased due to measures such as attractive currency swap rates for non-resident Indian deposits. Benchmark government bond yields are down more than 6% from August 19 peak of 9.24%. “Introduction of the seven-day and the 14-day repo could be the beginning for the development of a term repo market,” said B Prasanna, chief executive at ICICI Securities Primary Dealership.