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RBI officials checking why high reverse repo cutoff impacted long-term bonds

RBI officials checking why high reverse repo cutoff impacted long-term bonds

30 Sep 2021

NEW DELHI: In informal chats with some participants in the government bond market, officials from the Reserve Bank of India (RBI) are said to have made queries about the impact that the cutoff at Tuesday’s variable rate reverse repo auction – the highest so far in the year — had on the sovereign yield curve, sources told ETMarkets.com.

At Tuesday’s seven-day variable rate reverse repo auction worth Rs 2 lakh crore, RBI set the cutoff rate at 3.99 per cent, just shy of the repo rate of 4.00 per cent.

The cutoff was by far the highest so far this year and the first one which was more aligned to the benchmark policy repo rate rather than the reverse repo rate, which for around two years now has represented the effective cost of funds for money markets.

RBI’s move led to speculation in some quarters of the market that the central bank could be sending out a signal that it now wishes money market rates to head higher and be more in sync with the repo rate of 4.00 per cent rather than the reverse repo rate of 3.35 per cent.

What spooked the market more was the fact that the step came just a few days before the RBI’s next monetary policy announcement October 8, with some traders now feeling that it could be a precursor to a hike in the reverse repo rate.

The impact on the market was clear. While yields on short-term bonds on Tuesday eased on account of a lower-than-expected market borrowing number for Oct-Mar, those on longer-term securities rose on concern of imminent normalisation of monetary policy.

“There have been calls from RBI officials about why the long-term bond yields rose since the variable rate reverse repo should not directly impact such bonds,” a senior treasury official, who communicated with RBI officials, said. He preferred anonymity.

“The market feedback has been clear. There are some quarters of the market which are believing that it is a clear-cut sign that the October policy will either see RBI raising the reverse repo rate or will see the central bank setting a timeline for the same –probably starting December. Some traders did say that the market interpreted it as a quarter-end phenomenon, but the lingering question is why set it at 3.99 per cent just a few days before policy,” the official said.

Since the outbreak of the coronavirus pandemic in March 2020, RBI has taken several steps to keep borrowing costs low and shield the economy. These include large cuts in interest rates and maintenance of a huge surplus of liquidity in the banking system.

“Whether or not RBI hikes the reverse repo rate, the signal is clear that liquidity will no longer be permitted to remain in such a huge surplus,” another treasury official with the knowledge of the matter said.

“In fact, in some of the recent closed-door events between RBI and market participants, there have been substantial discussions about the liquidity situation and how to tackle it because RBI does not want to be caught behind the curve on inflation,” the official said.

For most of the last six months, core liquidity, which is the sum of liquidity in the banking system and the government’s cash balances, has been around Rs 10 lakh crore, far outstripping the previous record highs seen during the demonetisation period in late 2016.

In January 2021, RBI embarked on a fresh round of variable rate reverse repo auctions in what the central bank said was resumption of normal liquidity management operations in accordance with the revised liquidity management framework of February 2020, which had been suspended when the Covid-19 pandemic broke out.