Cash management bills, reverse repo to take care of excess liquidity

Surplus not to push inflation up, says deputy governor Viral Acharya

The Reserve Bank of India (RBI) on Thursday said it would use instruments such as cash management bills and the reverse repo to manage excess liquidity to bring it closer to the neutral position. This will ensure that excess money does not stoke inflation.

It will use the Standing Deposit Facility (SDF) after amendments have been made to the RBI Act. This would give the regulator more flexibility to manage its liquidity operations, the RBI said in its first monetary policy for 2017-18. It expects liquidity conditions to remain in surplus in the short run. 

Referring to the impact of excess liquidity on inflation, RBI Deputy Governor Viral Acharya said while liquidity was surplus, it was being drained out through a large quantity of “variable rate repos”. "As of now we have no reason to believe that there is leakage happening through that into inflation numbers," the deputy governor said.

Following demonetisation in November 2016, a persistently large structural liquidity surplus impacted the banking system.

The RBI uses conventional and unconventional instruments to ensure that the money market rates remain aligned to the repo rate.

Remonetisation accelerated in January-March with the currency in circulation increasing cumulatively by about Rs 4,37,300 crore in the fourth quarter.

This reduced the surplus liquidity in the system to Rs 3,14,100 crore by the end of March. The RBI said it would continue to moderate liquidity so that money market rates remained consistent with the operating target and the stance of monetary policy.

There was a gradual decline in the magnitude of the surplus from its peak in early January 2017. After the expiry of securities issued under the Market Stabilisation Scheme (MSS), the RBI progressively moved to variable-rate reverse repo operations for sucking out surplus liquidity. 

Dwelling on liquidity management operations in FY18, the RBI said the expansion in the currency in circulation would progressively drain out some of the surpluses associated with demonetisation. 

The remaining effects will be managed with variable reverse repo auctions, for which it would prefer to use instruments with longer tenors. 

It will continue to issue Treasury Bills and dated securities under the MSS to moderate liquidity from other sources. If required, durable liquidity will be managed through open market operations (OMO sales and purchases).

Fine-tuning operations in the form of variable rate repo/reverse repo auctions of various maturities will continue to be deployed.

The RBI had slapped the incremental cash reserve ratio (ICRR) of 100 per cent on bank deposits between September 16 and November 11, 2016, to draw out liquidity. It also used cash management bills (CMBs) and reverse repos to absorb liquidity. The peak level of liquidity absorbed had reached Rs 7,95,600 crore on January 4. 

The ICRR was in place for one fortnight (starting December 9, 2016), helping to drain out excess liquidity of Rs 4 lakh crore. The RBI withdrew the measure after the limit on issuing securities under the MSS was hiked from Rs 30,000 crore to Rs 6 lakh crore.

Problem of plenty

* RBI will use SDF after amendments have been made to the RBI Act. This will give the regulator more flexibility to manage its liquidity operations

* It expects liquidity conditions to remain in surplus in the short run

* Remonetisation accelerated in Jan-Mar with currency in circulation increasing cumulatively by about Rs 4,37,300 cr in the fourth quarter