Money market liquidity in India has averaged above Rs 7 tn on monthly basis since Aug-21.
Download ReportMARKET Musings: Normalizing liquidity and rates
India’s money market liquidity surplus has remained range bound at elevated levels since last 3-4 months. Short term money market rates, however, have hardened as a scale-up in term reverse repo auctions has led to a reduction in the liquidity free float. We expect core liquidity to moderate to Rs 9.5 tn by Mar-22 from Rs 11.2 tn currently, as demand for cash increases with sequential pick-up in economic recovery. Amidst persistence of surplus liquidity, reliance on term reverse repo auctions would be the preferred policy tool for calibration as it helps anchor money market rates while inherently being liquidity neutral. We continue to expect the RBI to restore the width of the policy rate corridor from 65 bps currently back to 25 bps by increasing reverse repo rate from 3.35% to 3.75% in a two-step move spread over Dec-21 and Feb-22. This would eventually pave the way for the next leg of interest rate normalization via repo rate. We expect yield curve to flatten further with 10Y g-sec yield seen at 6.50% by Mar-22. Meanwhile, COVID risks have resurfaced globally and need to be on active watch for implications for the timing of monetary policy normalization.