RBI to Signal Short-Term Rates as Traders Brace for Cash Drain

(Bloomberg) -- India’s central bank aims to drain two trillion rupees ($27.4 billion) from the banking system on Friday, in an auction that will provide traders essential clues on where the monetary authority wants to nudge short-term rates.

The cutoff for the 14-day reverse repurchase operation, conducted for the first time since the March pandemic-driven volatility, will let traders know just how much higher the Reserve Bank of India wants to drive money-market rates.

The RBI is draining excess cash after money-market rates crashed below its interest-rate corridor late last year, spurring calls from investors for it to remedy a situation that could distort banks’ asset pricing. Too sharp a rise could drive volatility, though, and raise concerns that the central bank is withdrawing stimulus support.

“The market will watch closely what cutoff the RBI gives,” said Pankaj Pathak, fixed-income fund manager at Quantum Asset Management Ltd. in Mumbai.

If it’s closer to the 4% upper bound of the interest-rate corridor than the lower bound at 3.35%, then the central bank “clearly wants shorter-term rates higher,” he said.

The cutoff rate is most likely to be 3.50%, according to the median estimate of seven traders polled by Bloomberg.

Shorter bonds sold off after the RBI’s announcement of the operation last week, as the market interpreted it as the start of a sooner-than-anticipated withdrawal of ultra-loose liquidity accommodation. The RBI has since met with bank executives to assure them that easy policy will continue.

RBI Said to Assure Bond Investors Over Its Easy Monetary Stance

The yield on the 5.15% 2025 bond has risen 13 basis points to 5.24% this week, and the government’s short-term borrowing costs rose on Wednesday in a sale of treasury bills.

The reverse repo auction alone may not be enough to support money-market rates given the high level of banking-system liquidity, according to ICICI Securities Primary Dealership Ltd. The RBI may need to provide more detail to reinforce its liquidity normalization process, such as laying out steps and a time table for a reversal of its emergency policy accommodation, economists including A. Prasanna wrote in a note this week.