Source says RBI only modulating liquidity, not removing accommodation

Monday, Jan 11, 2021


By T. Bijoy Idicheriah and Bhaskar Dutta


MUMBAI/NEW DELHI – The Reserve Bank of India's announcement last week on normalising liquidity operations must be seen as "modulation" of how it provides liquidity to the market rather than a step away from the accommodative stance, a banking industry source said.


"It is not a signal from RBI that it is tightening liquidity, just modulating how it provides it," the source told Cogencis.


"Liquidity will remain ample and comfortable in line with the Monetary Policy Committee's accommodative policy stance," the source said.


Post market hours on Friday, the RBI said it has "decided to restore normal liquidity management operations in a phased manner."


As part of the normalisation, the central bank announced a 14-day variable rate reverse repo auction worth 2 trln rupees for Jan 15.


Government bond yields rose sharply in response to the RBI's announcement, with short-term yields seeing the sharpest uptick. Yields on the most liquid 3-year and 5-year bonds shot up 12-16 basis points, while that on the 10-year benchmark paper rose as much as 6 bps.


Liquidity in the banking system has remained at a huge surplus over the last few months, with the current surplus estimated at around 6 trln rupees.


The excess liquidity has resulted in rates on several short-term money market instruments falling sharply, with several of them falling below the reverse repo rate, the lower bound of the RBI's monetary policy corridor.


In the wake of the economic crisis caused by the coronavirus pandemic, the RBI had temporarily suspended the revised liquidity management framework it had adopted in February 2020.


The step was taken to ensure ample liquidity in the banking system and to provide greater access to liquidity to foster market confidence.


The revised framework announced in February did not call for keeping liquidity in a 'close-to-neutral' deficit that was prescribed earlier.


The RBI had said at the time that with the weighted average call rate being the single operating target of the framework, there was no need to cap liquidity provision through fixed-rate repo and 14-day repo operations at 1% of net demand and time liabilities. Instead, the new framework calls for adequate provision or absorption of liquidity as warranted by market conditions, unrestricted by quantitative ceilings.


Though the RBI on Friday announced its intention to normalise liquidity management operations, the central bank had emphasised that it would continue to ensure availability of ample liquidity in the banking system.


In October, the RBI had given an explicit forward guidance stating that accommodation would continue into the next financial year starting Apr 1. The guidance was reiterated in the Monetary Policy Committee's December resolution.


Since the COVID-19 pandemic broke out, the RBI has lowered its repo rate by 115 basis points, and the reverse repo rate by 155 bps. This was on top of a cumulative 135-bps reduction in interest rates since February 2019, and large doses of liquidity injections into the banking system.


The RBI has also consistently stated its intent to utilise tools such as outright and special open market operations in order to assure market participants of access to liquidity and easy financing conditions.  End


Edited by Vandana Hingorani


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