Reserve bank of India directly moves to soak up liquidity from banks, hike in the cash reserve ratio (CRR) and how it would stabilise markets. These men know that a dip in growth and surge in deposits would force the central bank to lower interest rates sooner than later, pushes up bond rates and soften bond yields.
“A rate cut now is not conflict with cash reserve ratio (CRR) hike since this hike will be ultimately rolled back. The economy is at a stop now, so we should expect a cut. We were always expecting a 25-basis-point (bps) cut in December and another 25 bps later in the monetary, and we are sticking to our prediction” said Indranil Sengupta, chief India economist at Bank of America-Merrill Lynch (BofA-ML). It expects a total of 75 bps cut by September 2017.
Most economists believe a 25-bps rate cut to be a certainty next week as the central bank needs to support small and medium enterprises (SMEs) which have been hit by demonetisation of high-value notes.
CRR Hike an Incredible steps
The CRR hike announced a few days prior was just an extraordinary liquidity-absorbing measure rather than policy rate decision.
There is a widely shared perception that RBI may turn to more sophisticated policy tools to wipe up liquidity rather than impounding incremental deposits as CRR. Despite the fact that many may be hoping for a more aggressive rate cut by RBI in Wednesday’s monetary policy, chances are that the central bank may hold back ammunition for the future as the full impact of demonetisation unfolds by end March.
On 26 November, RBI asked banks to keep all incremental deposits garnered between September 16 and November 11 with the central bank to absorb the avalanche of liquidity in the banking sector after demonetisation was announced on November 8. RBI will survey these measures on 9 December.
Bond yields, which shot up 17-18 basis points soon after the CRR hike, have fallen almost 10 basis points since then.