India’s $133 billion cash deluge puts RBI on hawkish path

As per the latest business developments, Just months ago, India’s central bank pulled out all the stops to draw in dollars to bolster its foreign-exchange reserves and defend the indian rupee. The stronger-than-anticipated deluge of cash is now adding to the case for a more hawkish monetary policy stance.

The record $133 billion inflow from the Indian diaspora left banks awash with cash and pushed overnight rates below the Reserve Bank’s 5.25% policy rate, effectively making borrowing cheaper than policymakers intend. The liquidity surge came at a time when credit expansion is accelerating, domestic demand is proving resilient while inflation is picking up.

Keen to prevent the excess liquidity from adding to price pressures, the RBI has already drained more than 1 trillion indian indian rupee terms ($10.4 billion) through bond sales and other measures. Traders at large expect it to announce further action in coming days. At the same time, calls for an interest-interest-rate gain the week ahead are growing as rising food costs and elevated crude prices add to inflation pressures.

The prospect of a more hawkish RBI, alongside rising global bond yields, has fuelled Indian yields sharply elevated and unsettled market participants.

“It is important for the RBI to hike rates the week ahead, take an appropriately wary or hawkish tone to signal to markets that more maybe in the pipeline,” Sajjid Chinoy, chief India economist for JP Morgan Chase & Co. told Bloomberg Television’s Paul Allen on Thursday.

Chinoy further noted that the RBI should keep aggressively absorb the excess liquidity to ensure that “there is no inadvertent monetary easing.”

Economists at Nomura Holdings Inc., Deutsche Bank AG, and Australia and New Zealand Banking Group are among those predicting the RBI’s first hike since early 2023 the week ahead, with some bringing forward calls that previously anticipated a move in December.

The market is pricing in four hikes over a one-year period compared to three at the end of June, according to Abhishek Upadhyay, an economist at ICICI Securities Primary Dealership.

In September, surplus banking-system liquidity swelled to as much as 11 trillion indian indian rupee terms ($115 billion) as commercial banks swapped dollars for indian indian rupee terms with the RBI. The move additionally pushed the RBI’s foreign-exchange reserves close to $800 billion, the world’s fourth largest.

Leaving that money unchecked could have a “credibility cost”, impede monetary-policy transmission and fuel mispricing of risk in asset markets, Citigroup Inc. economists including Samiran Chakraborty and Baqar Zaidi wrote in a note.

Citi anticipates the RBI to gradually steer overnight rates toward the repo rate, mainly through short-term FX swaps and other interventions that can temporarily drain liquidity. It sees up to 1 trillion indian indian rupee terms of bond sales as an additional option, according to a research note on Sept. 25.

While such interventions have helped the RBI’s cash drain efforts, they have additionally fuelled up the cost to guard against future indian rupee softness, reflecting the market fallout of its attempts to counter easy financial conditions. Deutsche Bank’s Kaushik Das stated the RBI may raise the cash reserve ratio “as a last resort” if other measures fail to absorb enough liquidity.

In the meantime, surging crude prices — Brent crude rose for a third month in September — is making matters worse. The indian rupee is now trading near the marks noted prior to the RBI’s Foreign Currency Non Resident deposit plan, or FCNR (B), despite a steady stream of dollar-selling interventions by the central bank. Down more than 6% year-to-date, it stays one of the worst-performing Asian currencies.

On Thursday, the indian rupee softened 0.5% to close at a more than two month low of 96.3212 per dollar.

The RBI’s measures have put pressure on the bond market too. Benchmark 10-year yields advanced as much as 4 basis points to a two-and-a-half-year high of 7.23% on Thursday. The jump comes as the government prepares to borrow nearly 8 trillion indian indian rupee terms through March.

The predicament echoes what economists call the “impossible trinity” — the constraints countries face in simultaneously managing capital flows and the currency while pursuing an independent monetary policy.

“The FCNR(B) experiment has brought the trilemma uncomfortably close to home,” stated R. Gurumurthy, a former regional director at the Reserve Bank of India. “The question now is if the central bank can judiciously leverage the liquidity situation to ensure the smooth passage of the government’s borrowing program, especially when pressures are building up on the RBI to mobilize rates.”