Is RBI hinting towards hiking repo rates?

Reserve Bank of India (RBI) is indeed concerned about high liquidity, rising equity prices & high fiscal deficit and is taking steps towards liquidity management. Though RBI has kept the repo rate unchanged, it has hiked the cash reserve ratio (CRR), which can be seen as the first step towards a hike in the repo rates in the coming Monetary Policy Committee (MPC) meets. 

In February’s MPC meeting, RBI stated to increase the CRR in a phased manner in the next four months from its current level of 3 per cent, based on the assessment of systemic liquidity position. Having said, with effect from March 27, 2021, the CRR will be hiked by 50 bps to 3.5 per cent, followed by a further increase of 50 bps to 4 per cent from May 22, 2021, which is its pre-pandemic level. An increase in the CRR is expected to control the elevated inflation levels in the near future. According to RBI, consumer inflation is likely to be at 5.2 per cent during Q4FY21 and at 5.2 per cent to 5 per cent in H1FY22, although it is still above the targeted inflation level of 4 per cent. Regarding gross domestic product (GDP) growth, RBI predicts growth at 10.5 per cent in FY22 and in a range of 26.2 per cent to 8.3 per cent in H1FY22 along with 6.05 per cent in Q3FY22. 

The current systemic liquidity level stands at a surplus level of Rs 6.71 lakh crore as of February 4, 2021. The reserve money ascended by 14.5 per cent YoY (as of January 29, 2021), led by currency demand and the money supply (M3) after surging 12.5 per cent as of January 15, 2021. 

Amid higher fiscal deficit, RBI’s topmost priority is to control inflation while supporting growth. Therefore, RBI has maintained its accommodative stance, and due to comfortable liquidity position, it decided to restore the CRR to its pre-COVID level. 

Moreover, as RBI further normalises the policy it is likely to allow bond yields to rise by not actively managing the yield curve. Bond markets will test RBI in auctions by bidding at higher levels of yields.  The 10-Yearbenchmark bond yield is likely to inch up going forward on policy normalisation. Long-term bond investors are not going to like this. However, short-term bond investors are going to cheer. Furthermore, the increase in CRR may prove to be good news for bank fixed deposit (FD) buyers as the interest rates would rise and bad news for borrowers.