Indian central bank hikes overnight fund infusion post heavy FX intervention

By Dharamraj Dhutia

MUMBAI (Reuters) -India's central bank hiked the quantum of funds that it intended to inject into the banking system through an overnight infusion on Wednesday, after aggressively intervening in the foreign exchange (FX) market in the last two sessions.

The Reserve Bank of India (RBI) had offered to pour in 2.50 trillion rupees ($28.85 billion) through an overnight variable rate repo auction, the biggest infusion by the central bank in a single day in over a year.

Banks subscribed to 1.94 trillion rupees.

WHY ITS IMPORTANT

The RBI's constant intervention in the foreign exchange market has squeezed rupee liquidity. This tightness in the banking system will make last week's rate cut ineffective as lenders will not be able to transfer the benefit of lower rates to customers.

Most market participants have maintained that surplus liquidity conditions are a pre-requisite for the effective transmission of lower rates.

CONTEXT

India's banking system liquidity deficit quadrupled in less than a week to around 2 trillion rupees as on February 11, with traders citing tax outflows and aggressive dollar sales by the central bank among reasons for the jump.

The RBI sold between $4 billion and $7 billion on Monday as it intervened in the FX market to support the rupee. It continued selling dollars on Tuesday to shore up the currency that has been struggling due to portfolio outflows and uncertainty around U.S. trade tariffs.

The increase in the quantum of infusion comes a day after the central bank doubled the proportion of government securities that it aims to purchase to 400 billion rupees on Thursday. The RBI has infused over 1.5 trillion rupees into the system in the last one month.

GRAPHIC

KEY QUOTES

"Since the RBI promised liquidity infusion, which will also support rate cut transmission, any aggressive FX sale will curtail that intention. I believe the RBI will want to sterilise any large FX interventions that drain out domestic liquidity sizeably, to keep the latter around neutral in line with the monetary policy stance," said Dhiraj Nim, an economist at ANZ Research.

($1 = 86.7625 Indian rupees)

(Reporting by Dharamraj Dhutia; Editing by Sonia Cheema)