Variable repo rates in the offing

The Reserve Bank of India is likely to introduce variable repo rates in the credit policy on November 3.

Depending on the liquidity in the system, and the demand for and supply of funds, the central bank will offer variable repo rates to mop up excess liquidity in the market.

Although the central bank has been reining in expectations of a repo rate cut through various measures like introducing a 28-day repo auction and conducting a series of open market operations, some bond market dealers still anticipate a cut in the repo rate.

The market widely expects triple rate cuts in the credit policy: a bank rate cut of 25-50 basis point, a cut in the cash reserve ratio by 50 basis points, and a 25 basis points cut in the repo rate.

M A Ravikumar, head, global treasury, Standard Chartered Bank, said: "We expect the monetary policy to be business as usual. However, the bank rate and the cash reserve ratio could be cut. I also envisage some measures to stabilise the spot and forward foreign exchange market."

A repo rate cut is expected to help realign the flat yield curve. "Through continuous auctions and open market operations, the central bank seems to be nullifying the possibility of a repo rate cut. At the same time, the RBI's actions can be taken as a cue for raising the long-term rates, so that when the short-term rates are lowered through a repo rate cut, the steepness of the yield curve is maintained," said a dealer.

Currently, the yield curve is recovering, following a slew of RBI measures, after remaining flat for a long time.

When the repo rate was cut in August from 5 per cent to 4.5 per cent, the RBI thought that when the short-term rates fell, the yield curve would become steeper with the long-term rates remaining firm.

But amid a widespread belief that the soft interest rate bias would continue, the long-term rates fell drastically. So the yield curve continued to remain flat though the short-term rates fell.

There is some justification for a bank rate cut of 25-50 basis points, though the rate has lost relevance because few banks borrow from the RBI these days. A bank rate cut is seen as a token signal by the RBI that it is keen on soft interest rates.

The market also envisages a cut in the cash reserve ratio by 50 basis points, taking it closer to the target of 3 per cent. Currently, the cash reserve ratio stands at 4.5 per cent.