Move to hike MSS limit means a CRR cut and lower interest rates
It’s now clear as daylight that the Reserve Bank of India (RBI) will cut key rates in its December 9 policy review.
The decision by the RBI on Friday to hike the ceiling on the Market Stabilisation Scheme (MSS) to Rs 6 lakh crore from Rs 30,000 crore (a five-fold increase) to manage the surfeit of liquidity due to an uptick in bank deposits after the Centre’s demonitisation drive is evidence of the same, linked as it is to the withdrawal of the incremental cash reserve ratio (CRR) — the amount banks are to maintain with Mint Road as a proportion of their deposits — imposed on November 26.
The why and the how of it
The withdrawal of Rs 500 and Rs 1,000 notes as legal tender led to inflows of Rs 5.94 lakh crore into banks as deposits till November 27 as people rushed to exchange the new for the old.
With year-on-year (YoY) growth in deposits at 11 percent already ahead of credit given out (YoY) at 8 percent, it had led to a huge liquidity increase as there was more money with banks than what was being given out. Banks, in turn, invested this liquidity in government bonds which led to a sharp fall in yields. The yield on the 10-year government paper fell from 6.80 percent to 6.19 percent.
This surge in liquidity was also reflected in the amounts absorbed by Mint Road at its reverse-repo auction — the sums sucked out from banks by issuing government securities — at Rs 5.24 lakh crore. The pain point was that the RBI’s stock of government securities was then at around Rs 7.6 lakh crore and given that Rs 5.24 lakh crore of the same had already been exhausted, it meant there was little headroom if liquidity continued to increase.
And that’s why RBI Governor Urjit Patel had said that “While the RBI has a significant stock of government securities available, we felt that if the increase in deposits continues, we may fall short, hence the decision (to increase CRR). Once the government issues adequate quantum of MSS bonds, which they have promised to, we will immediately review the incremental CRR.”
You can cheer next week when banks cut lending rates after the RBI’s policy review. The festive season is clearly very much on even if cash is in short supply!
