Rising VRRRs indicate reverse repo hike

The hike in key policy rate was impending, is known to all. What is more important to see that how does increase in tools like VRRRs will act as a precursor to reverse repo hike at the ensuing monetary policy committee (MPC) meets.

Not to mention that the tone of the October minutes was similar to that of the August minutes, with dissenters Prof Varma, Dr Saggar and Dr Goyal arguing for (liquidity/policy) normalisation and accommodation to co-exist. The growth narrative, as indicated by Emkay, was largely similar across the board, with members agreeing on the need for durable growth, while some splits emerged on the persistence of inflation risks. The spillover of global uncertainties to the domestic growth outlook seemed to worry some, specifically Dr Patra, while Dr Saggar believed if no new disruptions to growth emerge, output gap may close sometime in FY23.

Analysts believe that a judicious mix of tools like VRRRs, OT/OMOs, FX forward intervention and part-rolling over of maturing FX forwards book will act as a precursor to reverse repo hike at the ensuing MPC meets. In contrast, RBI was not likely to deploy any direct tightening tools like MSS, CRR hikes, FX swaps or outright OMO sales in the coming quarters. On the other, the RBI may rely more on natural stabilizer tools such as increased credit offtake and high CIC so as to reduce the liquidity surplus.

Eventually, the recently released MPC minutes gave clear-cut indication towards the impending reverse repo hike, though time and quantum was difficult to guess at this point of time as things are still evolving on fronts like normalisation of economy due to fast waning of the pandemic. The RBI has been trying to redistribute/re-price existing liquidity by higher VRRR quantum/cut-offs, and has moved a step ahead by reducing further active liquidity infusion.

Even as the central bank may gradually do away with GSAPs, other tools like possible intervention via the FX forwards route, and partly rolling over its maturing forwards book will also remain preferred tools for liquidity management ahead. A judicious mix of these tools will serve as a precursor to a reverse repo hike in upcoming MPC meets in FY22.

The enhancement in VRRR size was initially interpreted as a precursor to reversal of liquidity measures leading to a transient spike in G-sec yield on the earlier policy day or August 7. Such fears, however, were later found to be unfounded.

In fact, any hike in key policy rates is unlikely until the February policy review or so. Moreover, the RBI may refrain from hiking the reverse repo rate, until the MPC changes the stance to neutral. After the repo hikes commence, we expect two increases of 25 bps each in April and June, followed by a long pause to assess the durability of the growth revival. Accordingly, the real interest rate, as per Icra, is likely to remain negative next year as well, albeit narrower than the current levels.