The Hindu Business Line : RBI may reinstate cap on reverse repurchases

Bangalore, Jan. 5 In a bid to contain cross-border arbitrage flows and exert further downward pressure on interest rates, the Reserve Bank of India is likely to reintroduce the daily cap of Rs 3,000 crore on reverse repurchases.

Reverse repurchases imply removal of excess liquidity through sale of securities. Top bankers said that the central bank was beginning to get concerned over the emergence of the US dollar as a carry currency. One source of the currency carry trade in dollar is the low interest funds raised through the US Federal Reserve Board’s Treasury Securities Lending Facility (TSLF).

TSLF is the Federal Reserve’s 27-day liquidity injection window that allowed American banks and savings institutions to borrow US Treasuries against an eligible basket of collateral of mortgage-backed securities, Collateralised Debt Obligations and asset-backed securitised papers. At the last TSLF auction on December 31, 2008, the TSLF pumped about $28.75 billion of liquidity at a stop-out rate (cut-off rate in Indian parlance) of 0.25 per cent. This allowed some US banks to swap and park in the reverse repurchase window at 5 per cent and earn a spread of close to 4 per cent.

Bankers said that it was the arbitrage operations that resulted in high bids at the last week’s reverse repos. Reverse repos accepted amounted to over Rs 76,925 crore, despite foreign institutional flows tapering off substantially. That many of the US banks were arbitraging was also evident from the trend in the short forward premium – cash to spot. This premium is currently about 5.08 per cent, far higher than the long forward premia.

Forward premium falls

Typically, the banking sources said, US banks raised the dollar resources at sub one per cent in the US markets and swapped for three days for rupees. The rupee resources were parked in the RBI’s reverse repurchase window during the period, which resulted in an interest spread realisation of about 4 per cent. With last week’s reduction, that interest spread was down to 3 per cent. The reduced spread was also likely to bring down the forward premia proportionately.

However, bankers said that if the cap of Rs 3,000 crore per day on the reverse repurchase window was reinstated, forward premia was likely to fall even more steeply. The last time the RBI had resorted to such steps was in March 2007 partly to close the arbitrage window, but this was withdrawn in July 07.

High lending rates

Bankers said that the case for reinstatement of the reverse repurchase cap also gained momentum from the RBI’s concern over high lending rates to the productive sectors of the economy. The high rates were apparent from wide spread between sovereign and corporate borrowing at over 500 basis points. This is despite the fact that over the last three months the Cash Reserve Ratio was brought down from a peak of 9 per cent to 5 per cent (effective from January 17 this year)

Few banks are, however, prepared to bring down the actual lending rates though they have dropped their respective benchmark prime lending rates, despite the increased liquidity of over Rs 2 lakh crore available to them. Instead, most banks preferred the reverse repo window for parking surplus liquidity instead of bringing down lending rates.

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