We expect the RBI to keep the policy repo rate unchanged in the upcoming monetary policy. However, there is a strong case for the RBI to change its stance from “withdrawal of accommodation” to “neutral”. Financial condition has tightened a lot in the last few quarters. Real rates are reasonably high and likely to increase further as inflation is trending down. Liquidity condition has also tightened with banking system liquidity running in deficit of over Rs. 2 lakh crore on daily basis. Its impact is clearly visible in the money market with AAA rated PSU banks issuing 3 months CDs at more than120 basis points above the policy Repo rate. In the last 5 years, this spread has been close to 30-50 basis points.
The RBI may announce some measures to address the persistent liquidity challenge in the baking system. They have already started conducting VRR (variable rate repos) auctions to provide liquidity for short durations. However, this is a temporary solution and will not be effectively solve durable liquidity shortages. Based on the historical trend of cash withdrawals, around Rs. 2 lakh crore can go out of banking system between February and May. Thus, a durable liquidity solation is required. The RBI might announce LTROs (long term repo operations) or FX swaps to infuse liquidity in a time bound manner.
Another key thing to watch in this policy would be the MPC’s voting pattern. After the last monetary policy, some MPC members openly advocated for a rate cut. We might see a split voting on rates this time with one or two MPC members voting for a rate cut.
Bond market is already pricing for a softer tone from the RBI. However, in case of split voting on rates market will increase the rate cut probability and yields might fall. RBI’s stance on liquidity can also influence the market in a significant way. By all means this is going to be a live policy.
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