Quantitative tightening by the RBI

The Reserve Bank of India announced further measures to contain foreign exchange volatility in India. The Central Bank has announced to tighten liquidity further by issuing Cash Management bills once every week for an undefined number of weeks. This underlines RBI’s resolve to contain inflation despite significantly weak economic growth outlook. Meanwhile, Treasury bill rates have increased beyond Bank Fixed Deposit rates and offer an interesting investment avenue to retail investors.

In its effort to contain the Rupee exchange rate volatility, the Reserve Bank of India has announced that it will auction Rs. 220bn (US$ 3.6bn) of cash management bills once every week on Mondays. The number of weeks for which these sales will be conducted has not been announced but in absence of any further details, this may be assumed open-ended. This measure follows other liquidity tightening measures that the RBI has taken over the recent few weeks including announcing a tight cap on the amount that banks can borrow from the central bank under its ‘liquidity adjustment facility’ window and raising the Marginal Standing Facility rate (under which banks can borrow from the RBI at a penal rate) by 200bps.

This comes at a time when economic growth in India is decelerating. According to RBI’s first quarter review (2013-14) of macroeconomic and monetary developments:-

“Recovery in growth may take time and is expected to shape slowly as the year progresses. Moreover, sustainable recovery requires control over consumer price inflation that has continued to hover around double digits for the past 15 months.”

This inflation fighting stand by the Reserve Bank of India in the face of weak economic growth is interesting. Meanwhile, the central bank today published a study titled ‘Real Interest Rate Impact on Investment and Growth – What the Empirical Evidence for India Suggests?’ on its website. The study concludes that while lower real interest rates are needed to stimulate growth, these cannot be achieved by adopting a policy of high inflation tolerance. Beyond a threshold the negative impact of inflation on growth outweighs its positive impact through lower real interest rate.  In other words, it underlines the central bank’s efforts to control inflation at the cost of short-term pains in the money-market.

Overnight call money rates have continued to remain high and may inch higher after today’s announcement. Meanwhile Treasury bills (and Cash Management bills) offer an interesting avenue for investment to retail investors. As can be seen from the chart here, T-bill rates are now offering higher than bank fixed deposits (FDs). Given the adverse effects RBI’s liquidity tightening measures are having on banks’ balance sheets (the Bank NIFTY index is down 13% since 15th July), it makes all the more sense from a credit perspective for retail investors to diversify funds out of Bank FDs into relatively safer Government bills.


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