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RBI signals policy shift with move to drain excess cash

Here’s a summary of the Moneycontrol article, along with key takeaways:
refer RBI signals policy shift with move to drain excess cash

Summary

India’s Reserve Bank (RBI) has shifted its strategy by draining excess cash from the banking system. On June 27, it’s set to conduct a ₹1 trillion (VNVRR) seven-day variable-rate reverse repo auction—the first time this has been used since November—to absorb surplus liquidity and realign short-term rates. This signals a move away from its prior stance of frequent liquidity infusions.

Key Points

  1. Liquidity Drain via VNVRR
  • RBI to auction ₹1 trillion through a 7-day variable-rate reverse repo on June 27, withdrawing surplus cash from banks (moneycontrol.com).
  1. Policy Tool Resurgence
  • It’s the first use of this tool since November, indicating a marked shift from liquidity addition to absorption (moneycontrol.com).
  1. Record Liquidity Surplus
  • The banking system holds an excess of around ₹2.3–2.4 trillion as of June 23 (reuters.com).
  1. Impact on Short-Term Rates
  • Reverse repo withdrawals aim to push overnight call rates closer to the repo rate, countering them staying near the lower Standing Deposit Facility (SDF) rate (reuters.com).
  1. Temporary Halt to Fortnightly Operation
  • RBI will skip its regular 14-day liquidity operation this week, underlining the change in stance (reuters.com).
  1. Background of Easing Measures
  • In June, RBI also implemented a 100 bps phased cut in cash reserve ratio (CRR), from 4% to 3% by September, boosting liquidity and improving transmission (fisdom.com, reuters.com).
  1. Market Response
  • Bond market saw a 6 bps decline in the 10-year yield to ~6.25%. However, short-term yields in the 10–15 bps range may rise (moneycontrol.com).
  1. Strategic Implications
  • Analysts view the move as RBI’s effort to bring operative rates in line with policy rates, enhancing monetary signal clarity (reuters.com).
  1. Signal of Policy Transition
  • This marks a shift from easing to fine-tuning liquidity to ensure rate transmission and control inflation (bloomberg.com).
  1. Potential for Further Operations
  • RBI may conduct more reverse repos if surplus persists, maintaining short-term rate discipline (moneycontrol.com).

Interpretation

  • The RBI is tightening operational liquidity, a tactical pivot from its earlier accommodative measures.
  • This move seeks to stabilize the overnight and short-term yield curve, improve policy transmission, and reaffirm the central bank’s credibility.
  • Investors can expect higher short-term rates, while medium- and long-term yields may remain anchored.
  • Banks will have less excess cash, potentially leading to tighter credit supply unless RBI offsets via CRR cuts.

The RBI’s move to drain excess liquidity through a ₹1 trillion reverse repo auction has several implications for gilt funds, especially short-duration and long-duration government bond ETFs. Here’s a detailed breakdown:

Implications for Gilt Funds

1. Short-Term Gilt Funds:

  • Likely Yield Increase: As RBI sucks out liquidity, short-term money market rates (1 day to 1 year) may rise slightly.
  • NAV Pressure (Mild): Bond prices move inversely to yields. Short-term gilt fund NAVs may see minor declines due to rising short-term yields.
  • Higher Reinvestment Yield: New money entering these funds may benefit from better accrual rates, improving future returns.

Example Impact: Funds like GILT5YBEES (5-year maturity profile) may experience small fluctuations if short-end yield curve steepens.

2. Long-Term Gilt Funds:

  • Less Direct Impact: Long-dated government bonds (10–30 years) are less sensitive to temporary liquidity actions unless inflation or repo expectations shift.
  • Stable or Bullish Bias: If RBI’s liquidity control is seen as anti-inflationary, long-term yields might stay steady or soften, supporting long-duration gilt NAVs.

Example: ETFs like LTGILTBEES (long-term gilt ETF) may remain stable or even benefit slightly.

3. Yield Curve Steepening Possible:

  • The overnight-to-5-year yields may rise, while the 10–30-year segment remains unchanged.
  • This steepening curve hurts short-duration gilts more than long ones.

4. Market Sentiment Shift:

  • The shift from “liquidity infusion” to “drainage” tells markets the RBI is cautious of excess liquidity leading to inflation.
  • This might prompt investors to move to ultra-short or longer-dated gilts selectively based on their rate view.

Discussion : Why is RBI borrowing money from banks now?
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