RBI Move to drain excess liquidity from system and its impact

RBI Move to drain excess liquidity from system

With a move to absorb the excess liquidity due to Demonitisation, RBI by its notification(annexed below)direct banks to increase its CRR( Cash Reserve ratio) by 100% of Net Demand and Time Liabilities(NDTL).

On the increase between September 16,2016 to November 11,2016, scheduled banks should maintain an incremental CRR of 100 percent, effective the fortnight beginning from November 26, 2016.

The RBI will review this move on December 9, 2016 or even earlier.

The Reserve Bank has also separately revived the Guarantee Scheme to enable deposit of SBN(Specified Banking Notes)balances at the Reserve Bank or at currency chests and get immediate value. This measure should also facilitate banks’ compliance with the incremental CRR.

How this move will Impact:

RBI came with a measure to suck out liquidity from banks. There has been huge deposits in banking system which is likely to gain further momentum. There is a limitation of total sterilisation by RBI which is around 7 lakh crore in reverse repo. This is a short term measure and will be reviewed by RBI on December 9,2016 or even earlier.

This temporary CRR hike is expected to take around 3.3 lakh crore of banking liquidity out. We think system is sitting on near 7 lakh crore excess liquidity, thus banking system will remain flush with excess liquidity even after this move. This move actually helps RBI to manage liquidity in absence of which overnight markets would have gotten completely dislocated .

It hurts banks as on such a large amount (3.3 lakh crore), banks don't get paid. It has some unique consequences on rates. Banks are likely to reduce fixed deposit rates even more sharply (because they earn zero on all incremental deposits, so why should they pay even 6% on 1 year FD, is how they will think) and thus it's likely that investors chase non-bank saving instruments even more. 

What happens to rates? It's likely that first order impact of this move is negative as some participants may read it a standard CRR hike. After this move we are expecting a Surge in Bond Yield and fall in Banking and reality stock mainly PSU Bank Stock.

Demonitisation has opened up space for steep rate cuts. We are expecting situation of disinflation and fall in GDP mainly in November and December 2016 due to liquidity crunch.


Below is the link for RBI Notification:
https://rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=10744