In an interview with this paper last week, Jayanth\u00a0R Varma, the lone voice of dissent in the Reserve Bank of India\u2019s (RBI\u2019s) six-member Monetary Policy Committee (MPC), said the \u201ceffective interest rate in the economy is not 4 per cent, but 3.35 per cent\u2026 lower than what is desirable.\u201d He has pitched for the removal of \u201csome of the accommodation which is no longer needed\u201d to \u201creduce the risk of loss of credibility (for MPC)\u2026 inflation becoming more entrenched and ultimately the need for higher rates in the future.\u201d<\/p>\n
Two days later, RBI Governor Shaktikanta Das, in an interview with another business daily, made it clear that the central bank wouldn\u2019t do anything in haste that may undermine financial stability in the medium term. \u201cWe need to wait for the growth signals to become more sustainable. We need to see that \u2026 the economic revival\u2026 the fast-moving indicators are not just fast moving, but take some roots\u2026 Any policy action by the RBI, particularly monetary policy action, has to be very carefully calibrated and well-timed,\u201d he said.<\/p>\n
Clearly, both are not on the same page. For a central bank, it\u2019s a dilemma between abundant and adequate liquidity. The case for appropriate liquidity is quite some time away. Those who want the normalisation process to start without any delay are looking for adequate liquidity, to start with.<\/p>\n
The RBI has two policy rates \u2013 repo and reverse repo. Both are now at their historic low: 4 per cent and 3.35 per cent, respectively. Paying the\u00a0repo rate, the banks borrow from the RBI when they need money; when they park excess liquidity with the central bank, they earn the reverse repo rate. So, the repo is the policy rate when there is appropriate liquidity in the system; the reverse repo becomes the policy rate when the systemic liquidity is abundant, like now.<\/p>\n
The timing of starting the normalisation process \u2013 either by draining excess liquidity more aggressively or raising the reverse repo rate \u2013 is critical. No one knows this better than former RBI Governor D Subbarao. He had flooded the system with liquidity and brought down the policy rate to its historic low (then) to insulate the Indian economy from the impact of the 2008 global financial crisis but was slow in starting the normalisation process. This led to inflation hitting the roof in 2013.<\/p>\n
Higher inflation and its impact on the economy is one side of the story. How have banks been dealing with excess money? Is it a liquidity trap\u00a0for economy\u00a0or liquidity drag\u00a0for banks?<\/p>\n
Between daily reverse repo and fortnightly variable rate reverse repo, the banking system has been parking Rs7-Rs8 trillion with the RBI. On a large part of this money, the banks earn 3.35 per cent. The last variable rate reverse repo auction price was fixed at 3.43 per cent. Since mid-January, the variable rate reverse repo auction has been absorbing Rs2 trillion every fortnight. From mid-August, the quantum has been raised in phases; by September-end, this window will absorb Rs4 trillion. Das has made it clear that the enhancement should not be misread as a reversal of the accommodative policy stance.<\/p>\n
The yield on the three-month treasury bill at this point is lower than the reverse repo rate \u2013 just 3.30\u00a0per cent. The yield on the six-month bill is 3.45\u00a0per cent and, one-year, 3.65 per cent.<\/p>\n
The banking system\u2019s holding of government securities was to the tune of Rs46.12 trillion\u00a0in mid-August\u00a0\u2013 around 30 per cent of deposits (Rs155.7 trillion), a loose proxy of the so-called net demand and time liabilities, against regulatory requirement of\u00a018\u00a0per cent. Apart from the dated securities, banks invest in treasury bills on which their earning is, at best, on average 3.5 per cent now.<\/p>\n
The long dated securities are kept in the\u00a0`held-to-maturity’\u00a0portfolio for which banks\u00a0does not<\/strong>\u00a0need to follow the mark-to-market (MTM) accounting practice, which dictates that a security must be valued at its prevalent market price and not at the price at which it was bought. They do keep the short-term securities \u2013 typically, maturing in\u00a0less than five years —\u00a0<\/strong>in the `available\u00a0for sale’\u00a0category, which\u00a0is subjected\u00a0to the MTM rule. Such securities\u00a0are\u00a0offering around 4.2 per cent yield now.<\/p>\n Overall, at least 10 per cent resources of the banking system are generating a return between 3.35 per cent and 4.2 per cent. For many banks, this is far lower than their cost of funds. In banking parlance, such investments are offering them a \u201cnegative carry\u201d.<\/p>\n The cost of funds for most large private banks and many public sector banks that have a handsome portfolio of the low-cost current and savings accounts, popularly known as CASA, could be 3.75-4 per cent. For others, it\u2019s 4.5-5 per cent. Many banks in the second group, too, have a large CASA base but they offer much higher interest rates on savings bank accounts in contrast to large banks, which pay just 2.75 per cent.<\/p>\n If we compare the return from reverse repo and treasury bills with the banks\u2019\u00a0<\/strong>marginal cost of funds based lending rate (MCLR), below which no bank can give loan, the negative carry is far higher. This rate factors in the marginal cost of funds, tenure premium, operational cost and the negative carry on account of cash reserve ratio (CRR). The banks don\u2019t earn any interest on the 4 per cent of deposits kept with the RBI as CRR.<\/p>\n The overnight and one-month\u00a0MCLR\u00a0of State Bank are the same — 6.65 per cent. The comparable rate for ICICI Bank is 7 per cent and IDFC Bank 7.9 per cent. The MCLR is fixed every month.<\/p>\n One can argue that keeping money in the RBI’s reverse repo window and buying short-term treasury bills are the bread-and-butter\u00a0of the banking system.\u00a0<\/strong>What’s the\u00a0<\/strong>big deal?\u00a0<\/strong>Also, not every bank has huge surplus cash. At least one large private bank has raised Rs5,000 crore certificate of deposits from the market in the past fortnight. But,\u00a0for sure,\u00a0none has seen this kind of liquidity sugar rush for such a protracted period.<\/p>\n Only credit growth can help banks to get out of this liquidity drag. That can happen when growth is secured, and not through loan <melas<\/em>>. But if that takes longer, the risk of higher inflation becomes real. This brings us back to the dilemma of abundant versus adequate liquidity. The time for appropriate liqudit has not come as yet.<\/p>\n","protected":false},"excerpt":{"rendered":" In an interview with this paper last week, Jayanth\u00a0R Varma, the lone voice of dissent in the Reserve Bank of India\u2019s (RBI\u2019s) six-member Monetary Policy…<\/p>\n","protected":false},"author":1,"featured_media":3067,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[],"class_list":["post-3066","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-articles"],"acf":[],"_links":{"self":[{"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/posts\/3066","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/comments?post=3066"}],"version-history":[{"count":1,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/posts\/3066\/revisions"}],"predecessor-version":[{"id":3068,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/posts\/3066\/revisions\/3068"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/media\/3067"}],"wp:attachment":[{"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/media?parent=3066"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/categories?post=3066"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/bankerstrust.in\/column\/wp-json\/wp\/v2\/tags?post=3066"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}