RBI's monetary policy review meet this week, will it start absorbing surplus liquidity?

The Reserve Bank of India (RBI) in the policy review meet this week is expected to keep the policy rate unchanged even as there is a growing view that the central bank may absorb some of the surplus liquidity in the system.

The monetary policy committee is scheduled to meet during October 6-8.

Surplus liquidity

The central bank in response to the Covid-19 pandemic had earlier cut repo rate—the rate which it lends to banks– to a low of 4% and injected additional liquidity into the system.

It is estimated that there is a surplus liquidity of Rs 10,000 crore in the system. The Times of India reported “many are now veering to the view that the central bank may absorb some of the surplus liquidity….to begin normalisation of the pandemic stimulus.”

The report further said the central bank is likely to follow a “divergent strategy” when it comes to interest rates.

According to another media report, Prof Jayanth R Varma, one of the six members of the Reserve Bank of India’s (RBI) monetary policy committee, is for a re-look at the accommodative stance.

Varma is suggesting a ‘neutral’ stance, which means keeping the system at a slight liquidity surplus position, but the interest rates could move upwards.

Forecast

The Times of India reported that Citi has forecast the RBI hiking its reverse repo rate—the rate which it borrows from commercial banks– signalling the return of economic activity to its pre-pandemic levels.

Meanwhile the inflation is forecast to hover around 5.7% in the current fiscal.

The Times of India report, quoted Bank of Baroda MD & CEO Sanjiv Chadha as saying, “You would expect that the liquidity piece will start getting normalised first. Change in the rate cycle is a few quarters ahead….,” said Chadha.

A reduction in liquidity will not make any change to the top-rated borrowers. It is also unlikely that any lender would touch home loan rates, according to the report.