RBI's bi-monthly monetary policy: Widening of liquidity corridor on the table?

RBI's move to bring down liquidity was one of the concern in April policy. Data suggest liquidity has come down since then.

The Reserve Bank of India (RBI) along with the six members of Monetary Policy Committee (MPC) will announce its bi-monthly monetary policy on June 7, 2017.

RBI has been categorical that “core inflation is sticky and there are upside risks to inflation from GST, El Nino, Pay Commission and geo political risks."

RBI, because of liquidity surplus, kept repo rate unchanged followed by a hike of 25 basis point in reverse repo rate at 6% from its previous 5.75% in April bi-monthly monetary policy.

Reverse repo rate is the rate at which the central bank borrows from banks.

Data released by the RBI indicates that after demonetisation, surplus liquidity in the system dropped from Rs 7,95,600 crore in January 2017 to an average of Rs 6,01,400 crore in February 2017 and further down to Rs 4,80,600 crore in March 2017.

RBI's action could be paying off when it comes to liquidity as latest data of RBI show net absorption from system has been declining and is at Rs 57,300 crore by end of May 2017 compared to Rs 1,06,700 crore in April 2017 and Rs 1,84,000 crore in March 2017.

State Bank of India (SBI) said, “A widening of the corridor or a signal on the SDF will be a well thought and pragmatic move to push the yields down and ensure monetary policy transmission against the backdrop of significant liquidity overhang in the system.”

Standing Deposit Facility (SDF) is a window for absorbing and dispensing liquidity in periods of tightness, that works without collateral (as in the case of the repo), and was recommended by the Urjit Patel committee report in 2014.

Reverse repo rate hike also comes as a measure to decrease inflation.

Consumer Price Index (CPI) has reached to a series low at 2.99% in the April 2017 well below market expectations of 3.5%following a 3.81% rise in March.

SBI, for FY18, expects CPI inflation to average below 4% with a significant downward bias.

Nikhil Gupta and Mahima Chaudary, analysts at Motilal Oswal said, “We expect CPI inflation to average 3.7% for the full-year FY18, lower than 4.5% in FY17 and also the RBI’s expectation of 4.75%. In our view, this presents a very strong case for at least one rate cut in 2017.”