India’s central bank take steps to ease liquidity

The Reserve Bank of India has cut the “marginal standing facility”, a short-term borrowing rate for banks and taken other steps to ease liquidity in the system.

India's central bank has rolled back emergency measures that were taken over the summer to defend the rupee as it plunged to record lows.

The Reserve Bank of India (RBI) on Monday evening cut the “marginal standing facility”, a short-term borrowing rate for banks, by 50 basis points to 9 per cent, along with steps to ease liquidity in the system.

The move further reverses measures that were put in place before the appointment of the new central bank governor, Raghuram Rajan, last month. Mr Rajan lowered the marginal standing facility by 75 basis points shortly after taking up the role.

Banking stocks on the benchmark BSE Sensex surged yesterday on the announcement, while government bonds rallied.

“The RBI is becoming more comfortable about the currency and a bit more concerned about domestic liquidity conditions,” said Leif Eskesen, the HSBC chief economist for India and Asean.

“The rupee has appreciated since late-August and remained relatively steady at the low 60s since mid-September. This has been achieved as a result of the various policy measures that India’s government and RBI have taken to restore stability in the currency markets and, of course, also the Fed’s decision to push back tapering.”

The Indian rupee slid to a series of record lows over the summer, hitting a historical low of 68.84 against the US dollar in August. This was largely driven by a flight of capital from emerging markets on expectations of the United States Federal Reserve winding down its stimulus programme as well as concerns about India’s gaping current account deficit.

“Mr Rajan has made clear that he hopes to phase out the use of the marginal standing facility, which implies that the marginal standing facility rate will be cut further and the repo lending cap raised or abandoned in the not too distant future,” said Mark Williams, the chief Asia economist at Capital Economics. “But concerns about stubbornly high headline inflation and the uncertain outlook for the rupee mean that a complete reversal of the summer’s policy tightening is unlikely, despite the continued weakness of the economy.”

He believes that the repo rate is likely to be raised by the end of the year, a view echoed by other economists.

“The RBI further rolled back the currency stabilisation measures as we had expected and infused more liquidity into the system to ensure that credit flows are not unduly constrained, especially during the festive season,” Mr Eskesen said. “The RBI is likely to continue to cut the marginal standing facility rate and infuse more liquidity, but is also expected to raise the policy [repo] rate tackle inflation.”