RBI to Infuse ₹2.50 Lakh Crore Liquidity

RBI to Infuse ₹2.50 Lakh Crore Liquidity

Subject: Economy

Section: Monetary policy

Infusion Details:

• The Reserve Bank of India (RBI) will inject liquidity amounting to ₹2.50 lakh crore via a 15-day variable rate repo (VRR) auction.

Liquidity Scenario:

• The overall funds deficit in the banking system widened to ₹3.34 lakh crore as of January 23, compared to ₹1.29 lakh crore on January 1.

Centre’s Cash Balances:

• Despite the Centre accumulating substantial cash balances with the RBI from GST and advance tax, liquidity pressure in the banking system persists.

Factors Contributing to Pressure:

• Banks are facing liquidity challenges due to outflows in the previous month related to GST payments and advance tax, while non-banking finance companies offer competitive returns.

RBI’s Liquidity Management:

• The RBI has been addressing liquidity concerns through various measures, including VRR auctions and long-term repo operations during the Covid-19 period.

Competition with NBFCs:

• Banks are encountering competition from non-banking finance companies as NCDs floated by NBFCs offer relatively higher returns compared to bank term deposit rates.

Investor Behavior:

• Retail investors are shifting from bank deposits to invest in mutual funds or equity markets, drawn by the bull phase in the stock market and IPO opportunities.

Expert Opinion:

• Experts suggest that liquidity pressure could ease if the government utilizes the accumulated balances with the RBI. Additionally, the RBI’s absorption of foreign portfolio investors’ dollars could enhance liquidity.

RBI’s Statement:

• RBI, in a December Monetary Policy statement, attributed liquidity tightening to factors like higher currency leakage, government cash balances, and RBI market operations.

MPC Stance Change:

• India Ratings and Research (IndRa) opines that sustained tightness in banking system liquidity could impact borrowers. It suggests a change in the Monetary Policy stance to ‘neutral’ to maintain consistency in stance and action.

Variable Reverse Repo Rate (VRRR):

Introduction:

• VRRR is the rate at which the Reserve Bank of India (RBI) borrows money from banks for a variable period, typically ranging from 14 days to 56 days.

Liquidity Management Tool:

• It serves as a tool for the RBI to manage liquidity in the banking system and influence short-term interest rates.

Auction Process:

• Regular VRRR auctions are conducted by the RBI to absorb excess liquidity from banks.
• Banks participate by bidding for the amount and specifying the interest rate at which they are willing to lend money to the RBI.
• The RBI determines the cut-off rate and the allotted amount based on received bids.

Interest Payment:

• Banks that bid at or above the cut-off rate are allotted funds, and the RBI pays interest to these banks for lending money.

Market Forces Determination:

• The interest rate paid is influenced by market forces, particularly the demand and supply dynamics of liquidity.

Implications of VRRR Auctions

Money Market Impact:

• Affects overnight money market rates like call money, CBLO, and market repo rates.
• VRRR rates’ increase leads to higher money market rates, reflecting tighter liquidity conditions.

Bond Market Impact:

• Influences bond yields, especially in the short end of the yield curve.
• Higher VRRR rates result in increased bond yields, indicating higher borrowing costs and reduced demand for bonds.

Banking Sector Influence:

• Affects the profitability and liquidity management of banks.
• Higher VRRR rates mean banks earn more on excess funds parked with the RBI.
• Balancing liquidity needs and returns becomes crucial for banks participating in VRRR auctions.

Variable Repo Rate:

1. Introduction:
   • Similar to Variable Reverse Repo Rate, the Variable Repo Rate is employed when the RBI aims to infuse liquidity into the economy.
2. Low Interest Rates Scenario:
   • Used when banks are reluctant to borrow from the RBI at Repo Rates due to existing lower interest rates in the economy.
3. Market-Determined Rate:
   • Banks are allowed to borrow at a rate determined by the market, usually lower than the Repo Rate, but not less than the Reverse Repo Rate.
4. Duration of Borrowing:
   • The borrowing period under the Variable Repo Rate is more than one day, providing flexibility to banks.
5. Liquidity Infusion Strategy:
   • RBI adopts this strategy to facilitate liquidity infusion even when banks may not find borrowing at standard Repo Rates attractive.

Repo Normalisation in India:

1. Repo and Reverse Repo as Control Tools:
   • The Reserve Bank of India (RBI) uses Repurchase Agreement (Repo) and Reverse Repo Agreement to manage money supply.
2. Quantitative and Qualitative Control:
   • Central banks employ quantitative or qualitative tools to control money supply.
3. Repo Rate Definition:
   • Repo rate is the rate at which the RBI lends money to commercial banks in case of fund shortfalls, involving the purchase of securities.
4. Reverse Repo Rate:
   • It is the interest rate paid by the RBI to commercial banks when they park excess liquidity with the central bank, serving as the opposite of the repo rate.
5. Repo Rate as Benchmark:
   • Under normal economic growth, the repo rate becomes the benchmark interest rate, influencing various interest rates in the economy.
6. Shift to Reverse Repo Rate:
   • When excess liquidity is pumped into the market without an uptake in fresh loans, the focus shifts from the repo rate to the reverse repo rate.

Reverse Repo Normalisation:

• Implies an increase in reverse repo rates, possibly in stages, aiming to curb inflation.

7. RBI’s Expected Action:
   • RBI may raise the reverse repo rate before the repo rate to narrow the gap between the two rates.
8. Inflation Control and Impact:
   • The normalisation process aims to curb inflation, reducing excess liquidity and leading to higher interest rates across the economy.

Monetary Policy Normalisation: The RBI adjusts the total money in the economy for smooth functioning, employing loose or tight monetary policies.

Loose Monetary Policy: Involves injecting liquidity and lowering interest rates to stimulate economic activity, encouraging consumption and production.

Tight Monetary Policy: As a countermeasure, it includes raising interest rates and withdrawing liquidity when a loose policy becomes counterproductive, aiming for policy normalisation.