Tuesday's Talking Points
From Deficit to Relief – RBI’s Strategy to stabilize Liquidity and Rates!
What’s the Point?
The Reserve Bank of India (RBI) announced on January 15, 2025 that it will conduct daily variable rate repo (VRR) auctions on all working days in Mumbai, until further notice. These daily auctions, aimed at easing the current liquidity tightness in the banking system, began on January 17, 2025, with a notified amount of ₹50,000 crore. For a while now, India’s liquidity conditions have remained in deficit zone with the average net Liquidity Adjustment Facility (LAF) deficit rising to a peak level of ₹2.5 lakh crore as on January 10, 2025 from ₹97,826 crore as on January 03, 2025, and overnight rates (Weighted Average Call Money Rate) rising from 6.11% to 6.88% during the same period. Tighter liquidity conditions suggest that yields may remain elevated, potentially delaying the start of a rate-cutting cycle. However, a softer Advance Estimate for FY25 GDP growth and lower inflation could accelerate the timeline for rate cuts, making them sooner than initially anticipated.
Numbers in Perspective
Source: Bloomberg, Centre for Monitoring Indian Economy (CMIE), @Fortnightly average of WACR has been plotted, Dates mentioned in the x-axis are the end of fortnight dates
What has led to Net LAF Deficit Levels to rise?
- Sale of Foreign Exchange (FX) Reserves: Over the past 1 year, RBI had been actively selling US Dollar (USD) for maintaining the stability of the Indian Rupee (INR), as evident from the table below, which has partly supported the INR. With the strength of the USD aided by rising treasury yields since the outcome of the US Presidential elections and overvaluation of INR, RBI could have decreased the rate of FX sales after a prolonged period of narrow range trading, leading to a steeper depreciation of the INR in the recent past – falling 2.9% between November 01, 2024 and January 20, 2025.
Table 1: FX Operations in Onshore / Offshore Over-The-Counter (OTC) Segment
Source: RBI Bulletin (January 2025 Edition)
- Volatile Movement in the Government Cash Balances: Government cash balances with the RBI have been volatile – increasing to ₹75,000 crore on January 20, 2025 from around ₹4,000 crore on January 15, 2025 – contributing to the tightness in liquidity. This was driven by usual quarter-end advance tax outflows and Goods and Services Tax payments.
Adverse Global Cues impacting Local Bond Markets in addition to rising Net LAF Deficit Levels
Rising LAF deficit levels could exert an upward pressure on yields, potentially impacting the Indian fixed income markets temporarily, and pushing the short-term borrowing costs higher. This could be a concern considering that adverse global cues could have been putting an upward pressure on Indian bond yields.
The December 2024 Federal Open Market Committee (FOMC) projecting a 50 bps Fed Rate cut in 2024 versus an anticipated 100 bps cut during the same period on earlier occasions, coupled with expectations of expansionary fiscal policies, have continued to push the US treasury yields higher. Between October 31, 2024 and January 20, 2025, the 2-year and 10-year US Treasury yields have risen by 11.2 bps and 34.3 bps respectively, steepening the spreads to 34 bps compared to 11 bps prior.
Furthermore, the last 1 month has witnessed Brent Crude Oil prices increase 10.4%, crossing the US$80 per barrel mark for the first time since October 2024 due to winter-led high demand and recent sanctions announced by US on Russian oil assets, which has led to deterioration in fixed income markets because higher oil prices often signal increased inflation expectations, which could lead to a spike in yields.
What are the bright spots for India?
While the above global factors were part-reasons for a delayed rate cut by RBI, the following have been witnessed:
- Government’s prudent fiscal consolidation path to the Budgeted Estimate of 4.9% for FY25 and supportive demand-supply dynamics have kept G-Sec yields under check
- India’s inflation (Consumer Price Index) has softened from its elevated level of 6.21% in October 2024 to 5.22% in December 2024, mainly led by a moderation in prices of key food items like cereals, pulses and oils and seeds, despite vegetable prices remaining elevated
- RBI has already taken a liquidity-boosting measure by cutting Cash Reserve Ratio by 50 bps – from 4.5% to 4%
These observations indicate that despite growth-inflation dynamics turning adverse earlier, interest rate cuts might not be denied, especially if Q4FY25 inflation are in line with RBI’s expectations. With the expectation of yields likely to trade with a downward bias, and the long end of the yield curve likely to outperform over the medium term, investors could use this opportunity to increase duration in debt portfolios.
Sources: Bloomberg, CMIE, RBI, Kotak Institutional Equities, and other publicly available information
About Tuesday’s Talking Points (TTP): TTP is an effort by HDFC AMC to guide key conversations in the Indian financial markets and investing ecosystem. We aspire to do this by providing relevant facts, along with our perspective on the issue at hand. If you have a topic that you would like to be featured here, please write to us at [email protected]
Disclaimer: Views expressed herein, involve known and unknown risks and uncertainties that could cause actual results, performance, or events to differ materially from those expressed or implied herein. Stocks/Sectors/Views referred are illustrative and should not be construed as an investment advice or a research report or a recommendation by HDFC Mutual Fund (“the Fund”) / HDFC Asset Management Company Limited (HDFC AMC) to buy or sell the stock or any other security. The Fund/ HDFC AMC is not indicating or guaranteeing returns on any investments. Past performance may or may not be sustained in the future and is not a guarantee of any future returns. Readers should seek professional advice before taking any investment related decisions.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
