Sunday, February 28

RBI group suggests longer term repo for liquidity management

KOLKATA: A Reserve Bank of India study group has recommended sticking to the current liquidity mechanism that targets the overnight call money rate hugging the policy rate, while suggesting longer term variable-rate repo or reverse repo as an alternative to open market operations.

The group has suggested minimizing central bank’s role in daily liquidity management while the new liquidity framework would incentivise banks to trade among themselves rather than with the central bank to make monetary transmission of policy rates more effective. It has also suggested standalone primary dealers be allowed to participate directly in all overnight liquidity management operations.

The framework is envisaged to avoid build-up of large surplus or deficit while a slightly deficit position would be favoured, in sync with the decade-long practice, which helps the policy rate to gravitate towards the call rate.

“It is important to ensure that liquidity operations should be consistent with the policy rate set by the Monetary Policy Committee. Liquidity management by the central bank should be aimed at achieving the first leg of transmission of the monetary policy, which is to align the target rate with the policy rate,” said the study group, which was mandated to review and simplify the current liquidity management framework.

The call money rate – with Weighted Average Call Rate (WACR) as the measure – will continue as the target rate of the liquidity management framework as it reacts to both surplus and deficit liquidity conditions, though asymmetrically.

Empirical analysis suggests that a deficit in bank reserves of Rs 1 lakh crore leads to a 11 basis points rise in WACR by 11 bps. While a structural surplus liquidity of Rs 1 lakh crore leads to a reduction in WACR by 4 bps. One basis point is one hundredth of a percentage point.

The group said that the daily primary liquidity management operation should be ideally one single overnight variable rate operation while the liquidity framework should entirely meet the liquidity needs of the system.

“Reserve Bank should stand ready to undertake intra-day fine-tuning operations, if necessary; however, such operations should be the exception to address unforeseeable intra-day shocks rather than the rule. Minimising the number of operations should be a goal of efficient liquidity management operations,” the group said.

The group suggested longer-term variable rate repos, of more than 14 days and up to one-year tenor to infuse liquidity as an alternative to OMO purchases. Similarly, longer-term variable-rate reverse-repos could be used to absorb excess liquidity. As these are possible substitutes for OMOs, these instruments should be operated at market determined rates.

There is no proposal to change in the difference of 25 basis points between the repo rate and the reverse-repo rate, as well as between the repo rate and the Marginal Standing Facility (MSF) rate. The standing liquidity facilities – fixed rate reverse repo and MSF – may continue as at present.

The group has suggested retaining the present minimum requirement of maintaining 90% of the Cash Reserve Ratio (CRR) on a daily basis as it has helped avoid bunching of reserve requirements of individual banks.

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