HYDERABAD: Interest rates can be lowered without tinkering benchmark policy rates. RBI just showed us how. On Thursday, it sprang a surprise Rs 1 lakh crore liquidity tool from its policy arsenal, which could prompt banks to reduce rates even though the six-member Monetary Policy Committee unanimously decided to hold repo rate unchanged at 5.15%.
That job of lower interest rates will now be done through long-term repos, which offer cheaper capital to banks, can boost liquidity and lending, tame bond yields, and can also enable quicker monetary policy transmission.
Introduced for the first time in India’s central banking history, long-term repos are Governor Shaktikanta Das’ latest convention-defying tool and these are slightly different from your usual repo.
A repo is nothing but a short-term repurchase agreement between RBI and banks. Typically, banks buy government securities from RBI at one rate and sell at a slightly higher rate. The difference then is the implicit interest, also known as the repo rate. Usually, such buying and selling happen overnight, or fortnight or slightly longer. So far, RBI’s longest repo has been 56 days. But beginning February 15, long-term repos will be available for 1 and 3 years, and at the prevailing rate of 5.15%. It means banks will have access to cheaper credit.
How does it work? According to Deputy Governor N S Vishwanathan, currently, banks are borrowing overnight from RBI, but those funds, instead of reaching borrowers, were going back to the central bank via overnight reverse repo. In other words, banks aren’t lending.
Now, with long-term repo, Vishwanathan believes, lending will be attractive as banks can borrow at cheaper rates from RBI. “It’ll bring down cost of funds for banks and will facilitate better transmission within the current constraints of downward rigidity of deposit rates,” said Rajnish Kumar, Chairman, SBI.
Das says the move was to ensure better monetary policy transmission. “We want to inject Rs 1 lakh crore into the banking system that will enable banks to reduce their lending rates,” he said.
According to RBI Governor Shaktikanta Das, the move to introduce long-term repo rates was to ensure better monetary policy transmission. “We want to inject Rs 1 lakh crore into the banking system that will enable banks to reduce their lending rates,” he said.
The impact was immediate and predictable. Yields on three- and five-year government bonds fell sharply by 10-15 bps soon after the announcement, though drop on the benchmark 10-year bond remained modest at about 4 bps. Analysts believe the impact will be greater than a repo rate cut in reducing bond yields.
Together with the so-called Operation Twist, RBI appears to be managing bond yields to encourage corporate bond markets and also ensure ample systemic liquidity, which anyway is in surplus at Rs 2-3 lakh crore. RBI also said that longterm repos won’t replace open market operations.
“Besides lowering rates in the short end of the sovereign curve, it’s also likely to lower corporate bond yields, deposit rates and lending rates,” said B Prasanna, head, global markets, sales, trading & research, ICICI Bank.
‘Won’t print money to cover fiscal deficit’
RBI has no plans to monetise the rising fiscal deficit by printing more currency, Governor Shaktikanta Das said. The government invoked an ‘escape clause’ under the Fiscal Responsibility and Budget Management Act, which allows it to relax fiscal deficit target by 50 bps.